TAXES AND TIMBER SALE INCOME
Article #81, March, 2004
By Bill Cook
It is getting a bit late, but not too late, to be thinking about how timber sale income from 2003 will impact your federal income taxes. There have been some changes to this year’s rules that favor forest owners. If you have had a timber sale on your property, you will want to allow some time for the paperwork.
First of all, it is not a good idea to simply avoid mentioning that you received income from a timber sale. That’s illegal and puts you in a disadvantaged negotiating position with the IRS. Also, it has become increasingly easy for the IRS to identify timber sellers through the expanding paper trail. Second, do not report the income as “ordinary” income like you would for wages and salary. Uncle Sam would be happy to accept more money from you than you owe, but most people would rather keep as much of their money as possible.
Three general tax reduction areas should be explored; 1) eligibility for capital gains treatment of the timber, 2) calculation of the timber “basis” and “depletion” deduction, and 3) deductions from the gross timber sale revenue. Each area involves corresponding records and tax forms. One of the 2003 changes includes revisions and clarification of definitions. Most notably, Form “T” Forest Activities Schedule has been redone and, no, you will not be able to find it at the library. If your tax preparer doesn’t have one, try the IRS at [www.irs.gov] or 1-800-829-3676.
Capital gains is the increase in value of capital property (land, houses, timber, etc.) over time. When you sell capital property, the income is treated differently than it would be if it were ordinary income. File using schedule D of the 1040 form. Capital gains tax rates are lower than those for ordinary income, with a maximum rate of 15 percent for timber sold after 6 May, 2003. Timber must have been owned for at least 12 months. Additionally under capital gains, you don’t have to pay the 15.3 percent in self-employment taxes (OASDI and Medicare) that you do for ordinary income.
Calculating a timber “basis” is fairly simple arithmetic, but the concept can be confusing. The calculations apply only to the timber on your property, separate from the land. A timber “basis” is the value of the timber when it was acquired, usually through purchase. You don’t have to pay taxes on those dollars invested in the timber, so you want your “basis” to be as high as reasonable. When you sell timber, a proportional amount of the basis can be deducted from the taxable timber sale income. If you have a clearcut, then 100 percent of the basis can be used a deduction. If you sell 50 percent of the timber volume, then 50 percent of the basis can be deducted. “Timber Depletion” is the IRS term for the draw on the timber “basis”. Form T is particularly helpful in reporting depletion.
Often times, figuring the value of just the timber at the time of acquisition can be a problem. Foresters and real estate agents can help establish what the common values were in a certain area in a particular year. If the timber has been owned for over 20 years, it is usually not worth the cost of calculating the timber basis. If the timber has been owned less than 10 years, then it is usually worth figuring out the timber basis.
Under IRS rules, a number of deductions can be made from the timber sale income. Costs associated with the timber sale can be deducted, such as consulting forester fees, attorney fees, etc. Also, there are certain longer-term costs associated with owning timber that may be eligible deductions. A professional tax preparer can help you determine which expenses should be deducted from timber sale income. Many times there are options and everyone has a different set of circumstances, so there isn’t always just a single “best” choice. Of course, you will want keep good records and hang on to those receipts.
If you want to learn more about federal income tax treatment of timber sales, there is a really good Internet source [www.timbertax.org]. This website contains many articles, topics, tips, and current information provided by the nation’s top forest taxation experts. Most forest owners will have only one or two timber sales in their lifetime. It is usually a good idea to work with a tax preparer familiar with timber taxation.
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Bill Cook is an MSU Extension forester providing educational programming for the entire Upper Peninsula. His office is located at the MSU Upper Peninsula Tree Improvement Center near Escanaba. The Center is the headquarters for three MSU Forestry properties in the U.P., with a combined area of about 8,000 acres. He can be reached at firstname.lastname@example.org or 906-786-1575.
by Bill Cook, Forester/Biologist, Michigan State University Extension, 6005
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