Metcalfe Forestry LLC
The tax treatment of timber sale income and management expenses is a highly specialized area of the federal tax code. Interpreting the provisions of Sections 631 (a) or 631 (b) requires the services of a professional forester. Many tax preparers do not encounter timber sales on a frequent basis and are not aware of the tax provisions or how to implement them for maximum tax savings.
Report timber income as LONG or SHORT-TERM CAPITAL GAIN. The tax code allows timber income to be reported as capital gain or as ordinary income. In all situations timber income receives much lower taxation if reported as capital gain, and eliminates the possibility of raising ordinary income to a higher tax bracket.
The first step is to create a DEPLETION ACCOUNT. All depletion accounts are based upon the actual cost basis of the timberland as of the date of acquisition whether by purchase, gift, or inheritance, and allocated into land and timber accounts using fair market values of the respective components of value at that date.
The value allocated to the trees is called the cost basis of the timber and is used to determine the Depletion Deduction. For example, if you sold a cord of timber for $20.00 and your depletion deduction was $10.00 per cord, your net taxable gain would be $20 minus $10, or $10.00. The depletion deduction is a tax free return of capital. The higher the depletion deduction, the less income tax you pay. The reverse is true as well. People who have recently purchased their timberland usually pay little or no tax on a sale of timber. People who bought their land a long time ago will pay more in tax because their cost basis is lower.
The next step is to record all MANAGEMENT EXPENSES associated with the timber sale and management of the property. Some management expenses such as: payments to a forester to sell the timber, advertising, contract expense,etc., can be directly deducted from timber income. Other expenses, such as: property boundary survey, tree planting, etc., will have to be capitalized into the cost basis and recovered through depletion. Either way, documenting all expenses will reduce the tax liability.
The final step is to prepare a FEDERAL FORM T which substantiates the depletion deduction, expenses, and capital gain or loss. The Form T is filed with the general income tax return at year-end.
If reported in this manner, timber income will receive a tax rate lower than your ordinary income marginal rate and you will not have to pay the 15.3 % self-employment tax (social security). When the depletion deduction is included, a savings of 30 % or more is possible on your tax bill.
Amended tax returns can be filed to claim a tax refund from previous timber sales. These returns must be filed within two-years of the original filing date. For most taxpayers this means three calendar tax years from April 15th of the current tax season.
We do not advise on, or prepare general income tax returns - we only specialize in timber. In that capacity, we can assess your potential tax savings, create your depletion account, and prepare the Federal Form T for you or your tax preparer.
James A. Burns
Forestry Consultant, A.C.F.
Jim Burns is a professional forester who owns and operates Burns Timber Tax Services and works in conjunction with Susan Metcalfe at Metcalfe Forestry CO. For more information call Susan at (989) 348-3596 with your questions.