TimberTaxationA General Guide forForestland Owners

College of Agricultural SciencesCooperative Extension

Authors: Stephen B. Jones, director,Alabama Cooperative ExtensionSystem, and Michael G. Jacobson,assistant professor of forest resources,Penn State.

The authors acknowledge the com-ments received by John Greene of theUSDA Forest Service.

This replaces Extension Circular#367, Timber Taxation: A GeneralGuide for Woodlot Owners.

Penn State College of Agricultural Sciences research,extension, and resident education programs are funded inpart by Pennsylvania counties, the Commonwealth ofPennsylvania, and the U. S. Department of Agriculture.

This publication is available from the PublicationsDistribution Center, The Pennsylvania State University,112 Agricultural Administration Building, UniversityPark, PA 16802. For information telephone (814) 865-6713.

Where trade names appear, no discrimination isintended, and no endorsement by Penn StateCooperative Extension is implied.

Issued in furtherance of Cooperative Extension Work,Acts of Congress May 8 and June 30, 1914, incooperation with the U. S. Department of Agricultureand the Pennsylvania Legislature. T. R. Alter, Director ofCooperative Extension, The Pennsylvania StateUniversity.

This publication is available in alternativemedia on request.

The Pennsylvania State University is committed to thepolicy that all persons shall have equal access to programs,facilities, admission, and employment without regard topersonal characteristics not related to ability, perfor-mance, or qualifications as determined by Universitypolicy or by state or federal authorities. The PennsylvaniaState University does not discriminate against any personbecause of age, ancestry, color, disability or handicap,national origin, race, religious creed, sex, sexualorientation, or veteran status. Direct all inquiriesregarding the nondiscrimination policy to the AffirmativeAction Director, The Pennsylvania State University, 201Willard Building, University Park, PA 16802-2801: Tel.(814) 865-4700/V, (814) 863-1150/TTY.

© The Pennsylvania State University 2000

1C/docu/4.9M2/00ps

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hile enjoying the benefitsof woodland stewardship,WPennsylvania forest owners

also bear certain social responsibili-ties. These include protecting waterresources, providing goods andamenities for present and future gen-erations, and paying appropriate for-est-related taxes. Forest-related taxescome in three forms: annual propertytaxes, income taxes, and if the valueof a gift or bequest is over a certainthreshold, gift and estate taxes. Thispublication discusses income taxes.Forestry taxation is a complicatedand somewhat confusing process. Aninformed landowner who worksclosely with competent profession-als—forester, accountant, lawyer, orother investment advisers—is in thebest position to deal with taxes re-lated to forest income.

Even if a woodland is intendedto provide only wildlife habitat or apleasant woodland setting for week-end retreats, a management plan mayeventually call for some form of com-mercial timber harvest. While the in-come from this sale is subject to in-come tax, it may be taxable as a long-term capital gain rather than ordi-nary income. Also, you may be ableto deduct management expenses,even during years when no harvest-ing income is realized.

The laws and regulations per-taining to forestland managementand income are complicated. Tomeet tax obligations, yet legally mini-mize the tax burden, taxpayersshould be familiar with appropriateelements of the federal tax law. Theinformation given in this circular willnot enable most landowners to per-form their own tax planning and ac-counting. But if you are a forestlandowner, it will introduce you to thecomplexity of forest taxation and ac-quaint you with important facts andprocesses so that you can communi-cate effectively with your forester andyour accountant. More detailed andspecific instructions are given in For-est Owners’ Guide to the Federal In-come Tax (see “Further Reading”).

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Federal Tax Form “T”

Record keeping and certain proce-dures related to timber-account man-agement are necessary componentsof the timber taxation process. Wewill set the stage for a more specificdiscussion of timber taxation by de-scribing the federal tax form thatguides most timber taxation recordkeeping and procedures. Federal TaxForm “T” (Timber), Forest ActivitiesSchedule, provides a convenient for-mat for forestry record keeping. It isorganized into nine sections or“schedules.”

2. If taxpayers have a large capitalloss, they can use it to offset amaximum of $3,000 of ordinaryincome. However, a large capitalloss can be applied against anyamount of capital gains.

3. Capital gains are not subject to the15.3 percent self-employment taxon income realized from a trade orbusiness (12.4% social security taxon income up to $72,600 for1999, plus 2.9% medicare tax onall income). Taxpayers who mate-rially participate in their forest en-terprise may fall within this cir-cumstance (see page 7).

Timber as a Capital Asset

Money spent to acquire real estate orequipment or to make improvementsthat increase the value of real estateor equipment already owned is classi-fied as a capital expenditure. Ex-amples of capital expenditures arepurchases of land, timber, and equip-ment with a useful life of more thanone year, expenditures for road andbridge construction,1 and expensesfor tree planting or seeding. Taxpay-ers cannot deduct capital expendi-tures from adjusted gross income theyear they are incurred. Instead, suchcosts must be capitalized. Capitaliza-tion is the process of recording ex-penditures in an account and recov-ering them over the life of the asset orat the time of disposition.

Land, timber, and equipmentare the basic capital accounts usuallymaintained in forest operations. As-sets placed in the land account in-clude the land itself, nondepreciableland improvements, and depreciableland improvements. Because neitherthe land account nor the equipmentaccount has elements unique to for-est ownership, this discussion will fo-cus on the timber account.

Timber has had long-term capi-tal gains treatment under the InternalRevenue Code (IRC) since 1944.The Taxpayer Relief Act of 1997substantially lowered maximumlong-term capital gain rates from 28percent to 20 percent. Under theAct, the rate is scheduled to drop fur-ther, to 18 percent for assets pur-chased and held five years beyondDecember 31, 2000. There are sev-eral major reasons for forestlandowners to ensure that their timbersale proceeds qualify for capital gainsstatus:1. The maximum tax rate for long-

term capital gains is only abouthalf the maximum rate for ordi-nary income (20% versus 39.6%).

1 The cost of surfacing a permanent road also isa capital expenditure, but the cost of roadmaintenance can be deducted.

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Schedule A, MapsSchedule A consists of a map of theforestland. Although filing the mapwith the income tax return is op-tional, the map must be available onexamination of the return.

Schedule B, AcquisitionsPurchases of timber, timber-cuttingcontracts, or forestland should be de-tailed in Schedule B. This scheduleprovides a format for recording costsassociated with such acquisitions andfor allocating total purchase costs toappropriate capital assets. For pur-chased forest property, the totalamount to be allocated is theproperty’s actual cost plus all otheracquisition costs. For inherited prop-erty, the amount allocated is the fairmarket value of the asset, usuallymeasured on the decedent’s date ofdeath. A gift, however, retains thedonor’s basis and allocation.

The value allocated to a particu-lar asset category, or account, is thebasis, or book value, of that asset.The asset categories included inSchedule B are “forested land,”“other unimproved land,” “im-proved land,” “merchantable tim-ber,” “premerchantable timber,”“improvements,” and “mineralrights.” For purchased or inheritedproperty, amounts are allocated tothe respective accounts according tothe asset’s relative value at the timethe property was acquired. A foresteror real estate appraiser can be helpfulin establishing relative values and de-termining allocations.

The premerchantable timber ac-count should be maintained as twoseparate subaccounts: (1) younggrowth (naturally seeded trees ofpremerchantable size) and (2) planta-tion (planted or seeded trees ofpremerchantable size). The mer-chantable timber account shouldcontain entries reflecting the timber’svolume and value at the time of ac-quisition. The premerchantablesubaccounts should contain entries

reflecting their acreage and your esti-mate of their contribution to theoverall value of the forest property.Keep in a permanent file any sup-porting documentation, includingproperty maps, timber cruise infor-mation, forester’s appraisals, andother materials relating to the acqui-sition and the allocation of basis.Good record keeping simplifies taxreporting and expedites the auditprocess if the IRS questions a subse-quent tax return.

Schedule C, Profit or Loss fromLand and Timber SalesSchedule C is used for recording andreporting all dispositions of timber,timber-cutting contracts, or forest-land. The gain or loss from a sale orexchange of timber is equal to the to-tal proceeds reduced by the adjustedbasis of the timber sold and by anyexpenses directly related to the trans-action. An example of how a timbersale affects the timber account is pre-sented later.

Schedule D, LossesIf there were losses from fire, insects,wind, or other causes during the taxyear and if they were claimed on the in-come tax return, document the natureand value of the loss in ScheduleD.

Schedule E, Reforestation andTimber Stand ActivitiesSchedule E is used to report expensesfor reforestation and timber stand im-provement during the tax year. Keepon file the detailed information neces-sary to support your entries in theschedule and be prepared to make itavailable upon examination of your re-turn. Report all expenditures that arerequired to be capitalized and itemsthat you elect to capitalize.

Schedule F, Capital Returnablethrough DepletionUse Schedule F to document and cal-culate adjustments to timber basis dueto growth, acquisition, sale, or otherchanges. The basis of each timber ac-count should be adjusted to reflectgrowth, harvest, acquisitions, lossesclaimed, capitalized carrying charges,and new-stand establishment activi-ties. The young growth and plantationsubaccounts should be adjusted to re-flect capital expenses incurred in con-nection with preparing a site for natu-ral regeneration or for planting orseeding. Establishment costs includemoney spent for site preparation, costsof seedlings or seed, costs of mechani-cal or chemical conditioning of thesite, costs of short-life tools (axes,dibbles, etc.), fencing costs, and costs

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Annual Deduction ofOperating Expenses

Besides understanding Form T re-quirements, forestland owners shouldknow how tax law affects their treat-ment of the ordinary and necessarycosts of forestland management.These costs may be expensed. Ex-pensing is the recovery of costs by de-ducting them in full in the year theyare paid or incurred. Forest manage-ment expenses, property taxes, andinterest can be deducted from alandowner’s ordinary income, subjectto a system of rules instituted by the1986 Tax Reform Act. These rules,referred to as passive loss rules, were in-tended to limit taxpayers’ ability touse paper losses from “tax shelters” tooffset income from other sources.Passive loss rules apply to individuals,estates, trusts, and some types of cor-porations. They are confusing anddifficult to interpret without the ben-efit of IRS rulings and case histories.Some background information mayclarify the complexities of deductingmanagement expenses.

Categories of Income-GeneratingActivitiesFor timber owners subject to passiveloss rules, there are three categories ofincome-generating activities for pur-poses of deducting expenditures, in-

of labor associated with those treat-ments. There are significant tax in-centives for reforestation, as dis-cussed under “Reforestation TaxCredit and Amortization.” As thetrees reflected in the young growthand plantation subaccounts becomemerchantable, an appropriateamount of basis and timber volumeshould be transferred to the mer-chantable timber account. In the ab-sence of additional timberland pur-chases and regeneration followingharvests, the young growth subac-count will eventually be reduced to azero dollar balance as the trees growinto the merchantable category.

Year-end quantity and basis arecalculated in Schedule F, providingyou with an adjusted basis and theinformation needed to calculate thedepletion unit, or basis per unit oftimber volume.

Schedule G, Land OwnershipChanges in the land account due toacquisition or disposal are reportedin Schedule G.

Schedule H, Road Construction,and Schedule I, DrainageStructuresSchedules H and I are for reportingactivities related to the constructionof roads and water-level control de-vices, respectively.

cluding timber management costs,taxes, and interest (see Table 1):• Portfolio (investment) income is de-

rived from savings accounts, bonds,stocks, and similar investments, in-cluding timber held for the produc-tion of income but not part of atrade or business. Management ex-penses associated with portfolio ac-tivities are deductible as miscella-neous itemized deductions againstincome from any source, but onlyto the extent that they exceed 2 per-cent of adjusted gross income whencombined with all other miscella-neous itemized deductions. Alter-natively, taxpayers can capitalizemanagement expenses for recoverywhen they sell or dispose of thetimber (taxpayers cannot capitalizethe expenses counted toward the 2percent floor for miscellaneousitemized deductions; they are lost).Property taxes are fully deductibleagainst income from any source.Interest on indebtedness related tothe timber is deductible only to theextent of net investment income.

• Passive business income is derivedfrom activities in which the tax-payer does not “materially partici-pate” (defined below) in managingthe resources used to produce theincome. Examples include incomefrom limited partnerships, somerental properties, and timber that islargely managed by others. Taxes,management expenses, and interestassociated with passive activitiescan only be deducted against pas-sive income.

• Active business income is derivedfrom wages, salaries, and other ac-tivities in which the taxpayer “ma-terially participates.” Income fromtimber held as part of a trade orbusiness in which the taxpayer ma-terially participates is active in-come. Management expenses,taxes, and interest are fully deduct-ible against income from anysource.

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estland in at least five of the lastten tax years. Under this test, tax-payers can still qualify as materi-ally participating in years theymade extensive use of hired con-tractors or professional foresters.

In each test, participation in-cludes the hours both you and yourspouse spent managing and operat-ing the forestland. But participationdoes not include time spent doingwork that is not considered “ordinaryand necessary” for timber manage-ment in your area. An example mightbe time spent establishing wildlifefood plots (unless the plots contrib-ute toward income earned from ahunting lease). Work done as an in-vestor also is not considered partici-pation—for example, studying andreviewing financial statements, pre-paring or compiling financial analy-ses, and monitoring finances or op-erations in a nonmanagerial capacity.

The greatest uncertainty aboutthe material participation tests is howthe IRS will treat participation byforestry contractors and consultingforesters. At least in the early stages ofan examination, the IRS may con-sider that owners who use the servicesof contractors and consultants do not“materially participate” in the man-agement of their forestland, even ifthe owners clearly reserve and exer-cise final authority in making man-

Because only the active incomecategory allows full recovery of allmanagement expenses, a forestlandowner usually benefits through mate-rial participation in managing theproperty as a trade or business. Meet-ing any of several tests of “regular,continuous, and substantial” in-volvement qualifies a forestlandmanager as materially participatingin managing his or her forestland ona year-to-year basis. The four mostapplicable tests are:1. participation in the management

and operation of the forestland formore than 500 hours during theyear. Most taxpayers will not ap-proach this level of participation.

2. participation in the managementand operation of the forestlandthat constituted substantially all ofthe participation during the year.In most years, there will be littledifficulty meeting this test.

3. participation in the managementand operation of the forestland formore than 100 hours during theyear, and the participation wasgreater than that of any other per-son. Only during particularly ac-tive years would most forestlandowners meet the 100-hourminimum.

4. material participation in the man-agement and operation of the for-

agement decisions. For this reason, itis recommended that you ensure youqualify under the terms of the fourthtest described by doing substantiallyall work required to manage and op-erate your forestland in years you donot use the services of contractors orconsultants.

Expenses Eligible for DeductionThe ordinary and necessary costs ofproducing a profit (broadly definedto encompass appreciation in treevalue) from an “active” timber-grow-ing operation qualify as deductibleoperating expenses. Examples includesalaries and wages, legal fees, businesstravel, small tools, timber stand main-tenance, and consulting fees.

Forms and Record KeepingActive forestland managers useSchedule C of Form 1040, and farm-ers list deductions on Schedule F ofForm 1040. If you are unable to meetthe requirements of active participa-tion, then as an investor you shouldlist expenses as miscellaneous item-ized deductions on Schedule A ofForm 1040.

It is important to maintain amanagerial diary as part of yourrecord keeping. Daily time reports,logs, or similar documents are not re-quired if material participation by“reasonable means” can be estab-lished. A managerial diary constitutesa reasonable means if it identifies ser-vices performed, records the approxi-mate number of hours you and yourspouse spent performing such ser-vices, and includes narrative summa-ries of each service performed. Thediary should be supported by receipts,contracts, and maps relevant to theactivities. Participating in forest-related organizations such as thePennsylvania Forestry Association,American Tree Farm System, or For-est Stewardship Program; using aconsultant or other professional for-ester; and having a management planwill also provide evidence of activeparticipation.

Table 1. Limitations on deductibility of management expenses, taxes,and interest.

Method of Holding Property

Type of Investment Business BusinessExpense (Portfolio) (Passive) (Active)

Management Deductible to the Deductible only Deductible againstExpenses extent they exceed against passive income from all

2% of gross income income sources

Property Tax Deductible against Deductible only Deductible againstincome from all against passive income from allsources income sources

Interest Deductible only Deductible only Deductible againstagainst interest against passive income from allincome income sources

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she does not hold the timber prima-rily for sale to customers.

Taxpayers wishing to generateactive income must dispose of thetimber on a pay-as-cut basis with aretained economic interest, or theymust cut the timber themselves andconvert it into products for sale toothers. In the first method, the tim-ber is sold on a unit basis, and the in-come qualifies as a long-term capitalgain under the provisions of Section631(b) of the Internal Revenue Code(IRC). Title to the timber transfers atfelling. The seller retains an eco-nomic interest and bears the risk ofloss until the tree is cut. In the secondmethod, timber cut by a landownerqualifies as capital gain under Section631(a) of the IRC if the owner spe-cifically elects capital gain treatmenton an original tax return, timelyfiled. Selling under either of theseprovisions allows a landowner to re-alize capital gains income and to havethe income qualify as active businessincome.

Gain or loss on a sale of timber isdetermined in the same way as forsale of assets in general. The total pro-ceeds from the sale or exchange arereduced by the basis of the asset andby all expenses directly related to the

Income from Timber Sales

Capital GainsFor most forestland owners, a sale oftimber is not a common occurrence.But when a sale does occur, impor-tant tax considerations should influ-ence management, record keeping,and reporting. Standing timber heldfor more than one year is a capital as-set, and income generated from itssale is a long-term capital gain. Logs,cordwood, fuel, and other productsfrom felled trees generate ordinaryincome. As stated earlier, capitalgains treatment of your timber saleprovides many benefits (see page 4).

Method of SaleA taxpayer may dispose of timberthrough one of three sale methods: alump sum sale, a pay-as-cut sale (Sec-tion 631(b) disposal), or treating cut-ting as sale (Section 631(a) transac-tion). A lump sum sale transfers titleof the standing timber to the pur-chaser before felling and relieves theseller of any retained economic inter-est. The income produced by thiskind of sale qualifies for capital gainstreatment only if the owner is an in-vestor or can demonstrate that he or

sale. Sale expenses may include adver-tising, timber cruising, marking, andscaling, and the fees of foresters, ap-praisers, lawyers, or other advisers di-rectly related to the timber sale.

Tables 2 and 3 illustrate the im-portant steps in calculating basis anddetermining the income from a saleof timber. The values shown in thetables reflect the transactions dis-cussed in the following example:

A taxpayer purchased a 40-acretract of timberland 11 years ago. Thevalue attributable to the 200 thou-sand board feet (MBF) of stumpageat $50 per MBF totaled $10,000. Anadditional 10 acres of adjoining for-estland with 50 MBF of timber waspurchased five years later, with$3,750 attributable to the timber ac-count. Estimated from forest inven-tory data collected by a professionalforester, timber growth on the prop-erties from date of purchase throughlast year totaled 50 MBF. Therefore,at the end of last year, the standingtimber volume was 300 MBF, thebasis in the timber account was$13,750, and the depletion unit was$45.83 per MBF ($13,750 dividedby 300 MBF).

For discussion purposes, the tim-ber is grown another year, then har-vested on a pay-as-cut basis duringthe fall (Table 3). As a result of theadditional year’s growth, the deple-tion unit rate is reduced to $44.35per MBF. The sale, a marked thin-ning, removes 100 MBF from the 50acres. The buyer pays the $200 perMBF he or she had bid for the sale.The sale was conducted by a consult-ing forester for a 15 percent commis-sion; in addition, the taxpayer in-curred another $500 of direct sale-related expenses. The gross receiptsof $20,000 (100 MBF x $200/MBF)were reduced by the adjusted basisand the costs of the sale, netting thelandowner a $12,065 return($20,000 – [$44.35/MBF x 100MBF] – [0.15 x $20,000] – $500).

Regardless of how timber is sold,taxpayers can allocate the sale pro-

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taxpayers may reduce federal incometaxes owed by $1,000 (0.10 x$10,000). This is a substantial incen-tive and should be explored by anyforestland owner contemplating har-vest and reforestation.

A related tax incentive allowsamortization of up to $10,000 of an-nual reforestation expenditures overeight tax years. On a qualified expen-diture of $10,000, taxpayers can am-ortize (deduct from gross income)$714 (1/14) in the year of the expendi-ture, $1,429 (1/7) in each of the sec-ond through the seventh years, andthe final $714 (1/14) in the eighthyear. This also is a substantial incen-tive, allowing forestland owners torecover part or all of their reforesta-tion expenditures without having towait until the timber grows to mer-chantable size.

If both the investment tax creditand amortization are applied to asingle reforestation activity, theamount amortized must be reducedby half of the tax credit taken. On aqualified expenditure of $10,000, theamount of the tax credit is $1,000(0.10 x $10,000) and the amountamortized is $9,500 ($10,000 – [0.5x $1,000]). Claim the reforestationtax credit on Form 3468; elect to am-ortize and claim the deduction onPart VI of Form 4562.

Cost Share Payments andConservation Reserve ProgramThe federal government and manystate governments offer cost-shareprograms to pay a part of the cost ofmanaging forestland. Federal cost-share assistance is available for prac-tices to reforest and improve timberstands (under the Forestry IncentiveProgram), restore lost or degradedwetlands (under the Wetlands Resto-ration Program), carry out steward-ship practices (under the Steward-ship Incentives Program), implementenvironmental conservation prac-tices (under the EnvironmentalQuality Improvement Program), and

Miscellaneous Federal TaxConsiderations

Reforestation Tax Credit andAmortizationAnnually, taxpayers may claim a 10percent investment tax credit on upto $10,000 of qualified reforestationexpenditures, including costs for sitepreparation, fencing, herbicides,seeds, seedlings, labor, and tools. Thesite must be at least one acre, locatedin the United States, and capable ofcommercial timber production. On aqualified expenditure of $10,000,

ceeds and calculate the net return us-ing Form T, Schedule C. Report along-term capital gain resulting froma lump-sum timber sale on Part II ofForm 1040, Schedule D, but reportordinary income on Schedule C or F.Report a long-term capital gain re-sulting from a Section 631(b) dis-posal or Section 631(a) transactionon Part I of Form 4797. From thereit will be transferred to Form 1040,Schedule D. In a Section 631(a)transaction, report the income thatresults from converting the standingtimber into products on Form 1040,Schedule C.

Table 2. Calculating basis in the timber account.

Quantity (MBF) Cost or Other Basis

Timber acquired in year 0 200 $10,000

Addition for 10 years growth 45 –

Timber acquired in year 5 50 $3,750

Addition for 5 years growth 5 –

Total available in December of year 10 300 $13,750

Depletion Unit = (Cost or Other Basis/Quantity)= $13,750/300 MBF= $45.83/MBF

Table 3. Determining gain or loss on a sale of timber (adapted from Form T,Schedule F).

Quantity (MBF) Cost or Other Basis

Estimated quantity of timber and amount ofcapital returnable through depletion at endof the immediately preceding tax year 300 $13,750

Addition for growth (period covered 1 year) 10 –

Total at end of year, before depletion 310 $13,750

Unit rate returnable through depletion – $44.35/MBF($13,750/310 MBF)

Quantity of timber sold during the year 100 –

Allowable basis of sale – $4,435(100 MBF x $44.35/MBF)

Total reductions during the year 100 $4,435

Net quantity and value at the end of the year 210 $9,315

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Christmas Tree ProductionIn general, most Christmas tree pro-ducers are subject to the same provi-sions as timber growers; the sale ofrooted trees does not qualify for capi-tal gains treatment. Christmas treesdo not qualify for the reforestationtax credit and amortization incen-tives, but since Christmas tree grow-ing almost always constitutes a busi-ness, management expenses, taxes,and interest are fully deductibleagainst income from any source. Thesale of Christmas trees is complicatedby a 1977 IRS Revenue Ruling. Inorder to ensure capital gains treat-ment, producers who sell standingtrees to wholesalers should be carefulto meet the requirements for a Sec-tion 631(b) disposal, while producerswho sell cut trees to wholesalers orchoose-and-cut trees to individualsshould be careful to meet the require-ments for a Section 631(a) transac-tion. Christmas tree production andtaxation are different enough fromtimber management to exclude theirfurther consideration here. Again,however, it is important to recognizethat the issues are potentially com-plex and are likely to warrant thecounsel of a tax professional.

develop or improve wildlife habitat(under the Wildlife Habitat Incen-tive Program).

Under IRC Section 126, a calcu-lated portion of cost-share paymentsfrom a qualified program may be ex-cluded from gross income, at thetaxpayer’s option. The excludableportion does not qualify for the refor-estation tax credit and amortizationincentives. Only cost-share paymentsthat are included in your gross in-come and your own out-of-pocketexpenses for the practice can be usedto calculate these incentives. The de-cision to exclude payments or toclaim the investment tax credit andamortization is influenced by yourincome and other considerations,and is beyond the scope of thisdiscussion.

Conservation Reserve Program(CRP) payments are not covered bythe IRC Section 126 exclusions andmust be claimed as ordinary income.At least part of a CRP cost-share pay-ment, however, may be deductibleunder the provisions of IRC Section175.

Casualty LossTo qualify as a recoverable casualtyloss, a timber loss must be traceableto a sudden and unexpected event.Examples are fire, high wind, ice, andhail. Insect and drought losses usu-

ally do not result in a casualty, al-though they may result in anoncasualty business loss deduction.Regulations allow the recovery oflosses only up to the basis value of thetimber lost, not its fair market value.The amount of loss must be estab-lished by a fair and objective proce-dure; depending on the extent of theloss, the services of a forester may berequired to establish this amount.The loss should be claimed as the dif-ference between the basis value andthe combined amount you receiveor expect to receive from any salvageoperation and insurancereimbursement.

Timber TheftTimber theft is handled in a similarfashion. Regulations allow recoveryof up to the basis value. You must re-port the date the theft was discoveredand document that it occurred.Again, a forester can assist in deter-mining the amount and value oftheft. Deduct theft losses in the yearof discovery and use the adjusted ba-sis value for that year. Report casu-alty losses and theft on Part B ofForm 4684. A loss of personal useproperty must exceed 10 percent ofyour adjusted gross income to be de-ductible; report such losses on Form1040, Schedule D.

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Estate TaxationAnother subject beyond the scope ofthis circular is the federal tax implica-tions of estate planning and manage-ment. Forestland owners should de-velop a comprehensive estate planthat fully considers tax consequences.Your estate-planning team should in-clude your attorney, tax professional,bank trust officer or other fiduciary,and forester.

Summary

The federal tax implications of forest-land ownership and management arecomplex and subject to change. Theintent of this circular is not to enabletaxpayers to perform their own taxplanning, but to increase their aware-ness of tax considerations so they canbe included in forest planning. Po-tential savings from proper timberand tax management are significant,particularly if commercial timber har-vests, management expenses, or refor-estation efforts are part of a forestmanagement plan.

Proper tax planning and imple-mentation involve a team effort byyou, your forester, and your tax pro-fessional. Taxpayers should:• make certain the forester and the

tax professional fully understandthe IRS rules applying to timber.

• establish a written forest manage-ment plan.

• keep records to the level of detailand for the length of time re-quired.

• enjoy the many benefits accruingfrom forestland stewardship, andavoid (not evade) paying unneces-sary taxes.

Further Reading

Forest Owners’ Guide to the FederalIncome Tax. 1995. U.S. Departmentof Agriculture Handbook No. 708.Available from the U.S. GovernmentBookstore, Atlanta, Georgia. Tele-phone: (404) 347-1900.

It is also available online at the Uni-versity of Georgia Extension Website: www.uga.edu/~soforext/forestmgmt/aghandbook.html(Note: this handbook is in the pro-cess of being revised and will be re-leased as USDA Handbook #718.)

Timber Tax Management Web Site:www.fnr.purdue.edu/ttax/ This siteis maintained cooperatively by thePurdue University Department ofForestry and Natural Resources andthe USDA Forest Service.

Estate Planning for Forest Landown-ers. 1993. USDA Forest Service,Southern Research Station. GeneralTechnical Report SO-97. Also avail-able from the U.S. GovernmentBookstore, Atlanta, Georgia. Tele-phone: (404) 347-1900.

The following magazines have regu-lar tax-related articles: Forest Land-owner (published by the Forest Land-owner Association, Atlanta, Geor-gia), Tree Farmer (published by theAmerican Forest Foundation, Wash-ington, D.C.), and National Wood-lands (published by the NationalWoodland Owners Association,Vienna, Virginia).

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Glossary

Account. A record of all transactionsthat affect one segment of a business.Examples are a land account, timberaccount, or equipment account.

Allocation. The process by which thecapitalized costs for purchases or im-provements are recorded to the ap-propriate capital account. For in-stance, if a 20-acre tract of land andtimber was purchased for $20,000,and the land and timber each ac-counted for $500 per acre of the pur-chase, then $10,000 is allocated toeach account.

Amortization. The process by whichthe basis of certain assets, such asqualifying reforestation expendi-tures, is recovered through deduc-tions over a specified period of time.

Basis. In general, the amount in-vested in a capital asset acquired bypurchase. The basis of property ac-quired by other means is determinedby the method of acquisition; seepage 9 for how to determine the basisof an asset acquired by gift or inherit-ance.

Capital gain or loss. The net incomerealized on the sale or exchange of acapital asset, such as land, timber,buildings, or equipment. A capitalgain is treated differently for incometax purposes from ordinary incomeor the profit realized from the opera-tion of a business.

Capitalization. The process of addingthe cost of acquiring a capital asset toa capital account. Depending on thenature of the asset, the capitalizedamount may be recoverable throughdepreciation, depletion, amortiza-tion, or only through sale or ex-change.

Cruise. The process by which the vol-ume, type, and quality of timberwithin a designated area is deter-mined. A cruise can be made by mea-suring each tree in the area—referredto as a timber inventory—or onlythose trees selected in a statisticallybased sampling system.

Depletion. The using up or wastingaway of a natural resource. In the caseof timber, depletion is the recovery ofthe owner’s basis in timber and ap-plies when the timber is harvestedand the products cut from thetimber are sold or used in the owner’sbusiness.

Depreciation. The process by whichthe basis of a capital asset with a de-terminable useful life is recovered asthe asset is used for the production ofincome. Capital assets associatedwith forest ownership whose basis isrecoverable through depreciation in-clude equipment, buildings, fences,temporary roads, and the surfaces ofpermanent roads.

Expensing. Also called deducting; therecovery of an expense by subtractingit from taxable income in the year itis paid or incurred.

Fair market value. The price at whichproperty, timber for example, wouldchange hands in a transaction be-tween a willing, informed buyer anda willing, informed seller. In a Sec-tion 631(a) transaction the timber orother asset must be valued as it ex-isted on the first day of the owner’stax year, regardless of any changesthat subsequently happen to it or tothe market.