Special Federal Tax Treatment Of Income Generated By A Timber Sale
The federal taxes on timber sale income and management expenses is a very specialized section of the tax code. Most tax preparers don't confront the sale of timber frequently enough to be aware of the proper federal tax provisions or how to use them for the greatest tax savings. Sections 631 (a) and 631(b) of the federal tax code refer to timber taxation.
If you have held standing timber for over 12 months Timber should be reported as long term capital gain. The tax code allows your timber income to be ordinary income or capital gain. Timber income always receives lower taxation when it reported as long term capital gain and removes the possibility of raising your ordinary income into the next higher tax bracket.
Short term capital gains are taxed at the same rates as ordinary income. Additionally you can only treat the value of standing timber as a long term capital gain if you have a IRC section 631(a) in effect. Make that election on Form T Part II.
Some taxpayers think that if they use capital gain treatment for their timber to save money from taxation, they'll be the target of an IRS audit. Nothing could be further from the truth. Timber tax laws recognize the legal fact that "standing trees, attached to the soil" are capital assets and have to be treated as such for tax purposes. Timber is not an area targeted by the IRS as an abusive tax shelter.
Additionally timber income does not fall under the list of "Tax Preference Items" which require the Alternative Minimum Tax calculation. The lower capital gain tax rate for income from your timber is not some recent change in the tax laws either. From the start of the federal income tax laws in 1913, timber has been recognized with special rules and rates. Recognizing that timber production is one of our most vital natural resources, the income tax laws are structured to account for the relatively long time period between crops by providing lower tax rates and deductibility of managing and operating expenses.
Your first step is to create a "depletion account". Depletion accounts are based on the actual cost basis of timberland as of the actual date of acquisition whether by purchase, gift or inheritance. They are allocated into land and timber accounts using fair market value of each component on that date. The value that is assigned to the trees is called the cost basis of the timber and is used to determine the depletion deduction.
Basis is a measure of your investment in timber. The total cost of acquiring purchased forestland should be allocated proportionately among capital accounts for the land, the timber, and other capital assets acquired with them. The fair market value of inherited forestland should be allocated similarly.
The depletion deduction is a tax free return of your capital. The higher the depletion deduction, the less income taxes you will pay. Often people who have recently purchased their timberland may pay little to no tax on a sale of timber. Conversely if you have owned your land for a long time your cost basis will be lower and more tax will be due.
You can take a deduction for timber lost in a casualty – an event that is sudden, unexpected, and unusual, like a fire, ice storm or hurricane. Start with the timber “block” that includes the damaged area (if you keep track of all your timber in one account, that is your timber block). Your deduction is the lesser of the decrease in value caused by the casualty or your basis in the timber block. Keep in mind the IRS may verify your basis and damage estimate.Report a casualty loss on Form 4684, Section B; adjust your timber basis on Form T, Part II.
You can take a charitable contribution deduction for donation of a permanent conservation easement. The amount you can deduct for 2008 is limited to 50% of your adjusted gross income, but your can carry forward any unused amount to be deducted over the next 15 years. If you generate more than 50% of your total income from a timber business, the amount you can deduct is limited to 100% of your adjusted gross income.
Next document all management expenses associated with the timber sale and management of your property. Careful recording of all expenses will reduce your tax liability. Expenses that can be directly deducted include: payments to a forester to sell the timber;advertising; cost of timber cruises;brush control, protecting the forest from fire, insects and disease, tools of short useful life, pre-commercial thinning, timber stand improvement, hired labor, and mid-rotation fertilization.
Keep in mind that expenses such as attorney fees, surveys, or other closing costs are included in your cost basis when you purchase or otherwise acquire property. Any subsequent capital expenses are also added to your costs basis. Property taxes and interest paid also are currently deductible, but you may elect to capitalize them if doing so provides a tax benefit.
If you receive payments from the sale or disposal of timber in 2 or more years, you can use the installment method to spread the income – and the tax on it – over the years you receive payments. Report an installment sale first on Form 6252, and then the amount can be carried over either to Form 4797 or Schedule D of Form 1040.
You may take annual depreciation deductions to recover your investment (basis) in property such as timber equipment, machinery, buildings, bridges, culverts, temporary roads, fences or the surfaces of permanent roads you placed in service for timber production. Cars, light-duty trucks, logging equipment, and road building Reporting and Tax Forms You are required to file a Form T (Timber) “Forest Activities Schedule” if you claim a timber depletion deduction, make a Section 631(a) election or sell timber outright under section 631(b).
Owners with occasional sales may be excepted from this requirement, but it is considered prudent to file. Even if you are not required to file Form T in a given year, it is an excellent way to keep your timber tax records. An electronic version of the form can be found at: http://www.irs.gov/pub/irs-pdf/ft.pdf.
Net taxable gain is determined for timber stumpage disposals (either lump sum or pay as- cut) by deducting from gross receipts the adjusted-basis and sale costs. When the owner cuts timber and elects to treat the cutting as a sale (a Section 631(a) transaction), net taxable gain is determined by deducting the adjusted basis (depletion allowance) from the fair market value of the standing timber on the first day of the tax year in which the cut occurs.
All three types of timber disposals are recorded on Part III, Profit or Loss From Land and Timber Sales, of Form T (Timber), Forest Activities Schedule. Net gains or losses are then reported on Form 4797, Sales of Business Property, and transferred to the appropriate Schedule D, Capital Gains and Losses.
The election to treat the cutting as a sale under Section 631(a) is made on Part II, of Form T (Timber), Forest Activities Schedule.To qualify for long-term capital gain treatment, you must hold your timber for more than 12 months. Timber held as an investment qualifies under IRC section 1221. Report a sale on Form 1040, Schedule D, Part II. Timber held as part of a trade or business qualifies under IRC section 631(b). Report a sale on Form4797, Part I, whether it was outright (lump-sum) or pay-as-cut.
If you as the owner cut standing timber yourself and sell cut products to a mill, all the proceeds are ordinary income unless you elect on Form T, Part II, to treat it as an IRC section 631(a) transaction. If you have a section 631(a) election in effect, the income from holding the standing timber is a capital gain and only the additional amount from converting the timber and transporting it to the mill is ordinary income.equipment generally are depreciated over a 5-year period.
If you purchased property for your timber business in 2008, you can elect to expense up to $250,000, subject to phase-out and taxable income limitations, up from $128,000. In addition, for property purchased and placed in service in 2008, a bonus depreciation in the amount of 50% of the property costs is available.
Remember these five points when filing your 2008 Federal income taxes on timber
1. Establish your basis as soon as possible and keep good records.
2. If you had a timber loss during 2008, you can, in most cases, only take a deduction for (casualty) losses that are physical in nature and caused by an event or combination of events that has run its course (fires, floods, ice storms and tornadoes). Remember that your deduction for a casualty or qualifying non-casualty loss is limited to your timber basis, minus any insurance or salvage compensation.
3. If you had Federal or State cost-share assistance during 2008, you are obligated to report it to the IRS. You may choose to exclude some or all of it but you must report it.
4. If you sold timber during 2008 you may be able to benefit from the long-term capital gains provisions on timber sale income which will lower your tax obligation.
5. If you have expenses for managing a forest, performed reforestation work or established significant timber stand regeneration costs, they may be deductible. If you own a forest to make money, ordinary and necessary expenses incurred for managing forest land as a business or an investment are deductible even if there is no current income from the property.
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SELLING TIMBER CAPITAL GAINS VERSUS ORDINARY INCOME
Income Tax Deduction for Timber Casualty Loss September 2008
The key for most cases is to figure out the adjusted basis of the standing timber.There is no deduction allowed if the basis is zero.
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