Taxes for Working Forests and Tree Farms Mark Megalos, Mark Megalos,& Rick Hamilton, NC RF Extension Forester, Retired

Taxes for Working Taxes for Working Forests and Tree FarmsForests and Tree Farms

Mark Megalos, Mark Megalos,

&&

Rick Hamilton, NC RFRick Hamilton, NC RF

Extension Forester, RetiredExtension Forester, Retired

Income Tax Income Tax ImplicationsImplications1.1.Timber Sales and BasisTimber Sales and Basis

2.2.Cost-Share PaymentsCost-Share Payments

3.3.Reforestation Tax IncentiveReforestation Tax Incentive

Timber SalesTimber Sales

Gross IncomeGross Income$50000$50000

Costs of SaleCosts of Sale (8500)(8500)

BasisBasis (21500)(21500)

Net Taxable IncomeNet Taxable Income

$20000$20000

Timber Sale (cont.)Timber Sale (cont.)

Net Taxable IncomeNet Taxable Income $20000$20000

Long-Term Capital Gains (LTCG)Long-Term Capital Gains (LTCG)

1 Year Holding Period1 Year Holding Period

For Both Investors and BusinessesFor Both Investors and Businesses

Report on Schedule D (Investors)Report on Schedule D (Investors)

Report on 4797 (Business)Report on 4797 (Business)

LTCG RatesLTCG RatesIncome*Income* Ordinary RateOrdinary Rate

LTCG**LTCG**$0-16,050$0-16,050 10%10% 0% 0%$16,051-65,100$16,051-65,100 15%15% 0% 0%$65,100-131,450$65,100-131,450 25%25% 15% 15%$131,451-200,300$131,451-200,300 28%28% 15% 15%$200,301-357,700$200,301-357,700 33%33% 15% 15%$357,701+++$357,701+++ 35%35% 15% 15%

*Married Filing Jointly, **2008-2012*Married Filing Jointly, **2008-2012

COST OF SALECOST OF SALETree markingTree markingScalingScalingCruisingCruisingTemporary roadsTemporary roadsConsultant feesConsultant feesLegal feesLegal feesAdvertising feesAdvertising feesSurveySurveyEtc….Etc….

Timber BasisTimber BasisWhy is it important?Why is it important?

• Basis reduces timber sale proceedsBasis reduces timber sale proceeds

• Basis or FMV (whichever less)=lossBasis or FMV (whichever less)=loss

• Only the Only the netnet amount is taxable amount is taxable

(Tax Code (Tax Code §1001(a))§1001(a))

An ExampleAn Example

• Joe Joe inheritedinherited a timber tract in a timber tract in Louisburg 2 years ago. Louisburg 2 years ago.

What is his timber basis? What is his timber basis?

Answer to the ExampleAnswer to the Example

• Timber quantity and price 2 years Timber quantity and price 2 years ago in Joe’s land:ago in Joe’s land:– Pine sawtimber Pine sawtimber 100 tons x $30/ton 100 tons x $30/ton = $3,000= $3,000– Pine pulpwood Pine pulpwood 200 tons x $6/ton 200 tons x $6/ton = $1,200= $1,200– Hardwood pulpwood Hardwood pulpwood 300 tons x $4/ton 300 tons x $4/ton = $1,200= $1,200

$5,400$5,400

Land with Pre-Merchantable Land with Pre-Merchantable TimberTimber

• The FMV of timber generally means The FMV of timber generally means $/acre$/acre

Special Tips for Timber BasisSpecial Tips for Timber Basis

• Timber basis has Timber basis has two partstwo parts: :

•timber quantity and timber quantity and

•$ value$ value

(Tax Regulation (Tax Regulation §1.611-3)§1.611-3)

Special Tips for Timber BasisSpecial Tips for Timber Basis

• Basis must be allocated Basis must be allocated between between land land aand nd timber timber

(Tax Regulation (Tax Regulation §1.611-3)§1.611-3)

Timber BasisTimber Basis

• For For purchasedpurchased property, timber basis property, timber basis is theis the purchase pricepurchase price plus acquisition plus acquisition costs costs

Timber BasisTimber Basis

• For For giftedgifted property,property, if no gift tax is paid, if no gift tax is paid, the basis is: the basis is:

(a) donor’s adjusted basis (gain at disposal)(a) donor’s adjusted basis (gain at disposal)

(b) the lower of the donor’s adjusted basis or the (b) the lower of the donor’s adjusted basis or the FMV (loss at disposal) FMV (loss at disposal) ( (§1015 and §1.1015)§1015 and §1.1015)

ADJUSTED BASISADJUSTED BASIS

Original plus:Original plus:Capitalized ExpensesCapitalized ExpensesCarrying chargesCarrying chargesCapital improvement investmentCapital improvement investment

OROR

Original Minus:Original Minus:DepletionDepletionCasualty loss deductionCasualty loss deductionBusiness loss deductionBusiness loss deduction

BACK CRUISEBACK CRUISEUse to establish a basisUse to establish a basis

Allocates timber value at time of acquisitionAllocates timber value at time of acquisition

4 step process4 step process1.1. Determine present volumeDetermine present volume2.2. Estimate growth over period since acquisitionEstimate growth over period since acquisition3.3. Reduce present volume by growth Reduce present volume by growth 4.4. Volume past X stumpage past = BasisVolume past X stumpage past = Basis

Note: Limited by purchase price or by FMV Note: Limited by purchase price or by FMV accepted by IRSaccepted by IRS

ESTIMATED TAX ESTIMATED TAX FROM TIMBER SALESFROM TIMBER SALES

Estimated taxes should be paid on Estimated taxes should be paid on income resulting from a timber sale.income resulting from a timber sale.

Exceptions: Farmers with at least 2/3 Exceptions: Farmers with at least 2/3 of their income from agriculture, are of their income from agriculture, are exempt from filing estimated tax.exempt from filing estimated tax.

Timber Investment or BusinessTimber Investment or Business

ANNUAL EXPENSESANNUAL EXPENSES

Interest on loansInterest on loansTimber insuranceTimber insuranceRoad and fireline maintenanceRoad and fireline maintenanceInsect and disease protectionInsect and disease protectionPrescribed burningPrescribed burningAdministrative feesAdministrative feesLabor, tools, materialsLabor, tools, materialsTSITSIProperty taxesProperty taxes


TIMBER INVESTMENT OR BUSINESSTIMBER INVESTMENT OR BUSINESS

InvestorInvestor – not a major or regular – not a major or regular source of income, but being source of income, but being managed for eventual profit. managed for eventual profit.

Does not deduct expenses as Does not deduct expenses as business expenses.business expenses.


TIMBER INVESTMENT OR BUSINESSTIMBER INVESTMENT OR BUSINESS(cont’d)(cont’d)

BusinessBusiness – Factors: – Factors:1.1. Frequency and substantiality of salesFrequency and substantiality of sales2.2. Reason, nature and intent of acquisitionReason, nature and intent of acquisition3.3. Duration of ownershipDuration of ownership4.4. Taxpayers principal businessTaxpayers principal business5.5. Extent and nature of taxpayer activitiesExtent and nature of taxpayer activities6.6. Extent and nature of the salesExtent and nature of the sales7.7. The presence or absence of an officeThe presence or absence of an office8.8. The character and degree of supervision The character and degree of supervision

or control the taxpayer exercises over or control the taxpayer exercises over any agent or representative selling the any agent or representative selling the propertyproperty

9.9. Likely deducts expenses as business Likely deducts expenses as business expenses on schedule C of F.expenses on schedule C of F.


PASSIVE LOSS RULESPASSIVE LOSS RULES

1.1.Timber is held as part of a trade or Timber is held as part of a trade or business in which the taxpayer business in which the taxpayer materially participates.materially participates.

2.2.Timber is part of a trade or business Timber is part of a trade or business in which the taxpayer is not a in which the taxpayer is not a material participant (passive).material participant (passive).

3.3.Timber held for the production of Timber held for the production of income (investment) not a part of a income (investment) not a part of a trade or business.trade or business.


MATERIAL PARTICIPATIONMATERIAL PARTICIPATION1.1. 500 or more hours/year.500 or more hours/year.2.2. Taxpayer does substantially all activities.Taxpayer does substantially all activities.3.3. More than 100 hours and this is at least as More than 100 hours and this is at least as

much as anyone else.much as anyone else.4.4. 500 or more hours in all businesses and the 500 or more hours in all businesses and the

forest business is a significant portion of the forest business is a significant portion of the total.total.

5.5. Taxpayer has been a material participant for 5 Taxpayer has been a material participant for 5 or the past 10 years.or the past 10 years.

6.6. More than 100 hours and based on facts and More than 100 hours and based on facts and circumstances participates on a regular, circumstances participates on a regular, continuous, substantial basis.continuous, substantial basis.


ACTIVE (MATERIAL) BUSINESSACTIVE (MATERIAL) BUSINESS

Management expenses deducted as Management expenses deducted as business expenses with no limit on business expenses with no limit on schedule F or C or expenses may be schedule F or C or expenses may be capitalized.capitalized.

Note: If expenses are capitalized, a Note: If expenses are capitalized, a statement of the amount and decision statement of the amount and decision to capitalize should be attached to to capitalize should be attached to the year’s tax return.the year’s tax return.

Timber Investment or BusineTimber Investment or Businessss

PASSIVE BUSINESSPASSIVE BUSINESS

Management expenses deducted Management expenses deducted as business expenses but only to as business expenses but only to

the extent of passive income the extent of passive income from other passive activities. from other passive activities.


INVESTMENTSINVESTMENTS

1.1. Management costs – miscellaneous itemized Management costs – miscellaneous itemized deductions subject to 2% floor or capitalized. deductions subject to 2% floor or capitalized. Deducted on schedule A or Form 1040Deducted on schedule A or Form 1040

2.2. Property taxes – fully deductible.Property taxes – fully deductible.3.3. Interest – deductible to the extent of net Interest – deductible to the extent of net

investment income or capitalized.investment income or capitalized.

Note: If expenses will be capitalized, it is Note: If expenses will be capitalized, it is recommended that a written summary of this recommended that a written summary of this decision be attached to that year’s return.decision be attached to that year’s return.

Reforestation Tax Reforestation Tax TreatmentTreatment

1.1. FirstFirst $10,000 is fully deductible $10,000 is fully deductible

2.2. Write-off (84-months) of all amounts Write-off (84-months) of all amounts over $10,000over $10,000

3.3. Both deductions taken as “Adjustments Both deductions taken as “Adjustments to Income” (no need to itemize)to Income” (no need to itemize)

4.4. Equally available to small businesses Equally available to small businesses and investors.and investors.

5.5. Elected on a property by property basis Elected on a property by property basis each tax year.each tax year.

6.6. May not include cost-share amounts May not include cost-share amounts excluded from income (IRC 126)excluded from income (IRC 126)

EXCLUSION OF EXCLUSION OF COST-SHARE PAYMENTSCOST-SHARE PAYMENTS

1.1. Must be for approved practices under Must be for approved practices under approved programs. Rental payments approved programs. Rental payments such as CRP do not qualify. Neither do such as CRP do not qualify. Neither do payments for perpetual or temporary payments for perpetual or temporary easements.easements.

2.2. Payment must not substantially Payment must not substantially increase the gross receipts of the increase the gross receipts of the landowner from the property being landowner from the property being improved.improved.

Cost Share Cost Share - To Wait or - To Wait or Not?Not?• Reforest Reforest

Immediately - No Immediately - No Cost ShareCost Share

$75 Cost/Acre

($18.75) Tax Deduction@25%

$56.25 Net Cost

Waiting for Cost Waiting for Cost ShareShare $ 90 Site prep

$ 75 Planting cost

$165 Total Cost

($ 66) Less 40% Cost share (excluded)

($ 24.75) Less tax deduction @25%

$ 74.25 Net Cost

Cost Share or Not - Cost Share or Not - SummarySummary

NotNot

$56.25 Net Cost$56.25 Net Cost

WaitWait

$74.25 Net Cost$74.25 Net Cost

Loss of $60-$100 Loss of $60-$100 annual gross annual gross

incomeincome

Tax ResourcesTax Resources• National Timber Tax Website: National Timber Tax Website:

www.timbertax.org

Ruraltax.orgRuraltax.org– Extensive: Income, estate and property lawExtensive: Income, estate and property law– Professional referencing Professional referencing

• Service and Publications by Service and Publications by ExtensionExtension, , State AgencyState Agency and and UniversityUniversity

http://www.timbertax.org/

Federal Income Tax Changes Affecting Agriculture

• Individual Income Tax Rates– 10%, 15%, 25%, 28%, 33%, 35% AND

39.6% for $400,000 MFS; $450,000 MFJ; $425,000 for HoH

– The bill permanently keeps the 10 percent bracket


• Capital Gain Income Tax rates– 0% for taxpayers in the 10 and 15% income tax

brackets– 15% for taxpayers in the 25, 28, 33, and 35%

income tax brackets


• Capital Gain Income Tax rates– 20% for taxpayers in the 39.6% income tax

bracket• >$400,000 taxable income for singles• >$450,000 taxable income for MFJ

– However, a 3.8% Medicare surtax hits folks with AGI over $200,000 and $250,000 on capital gains: 18.8% or 23.8% rates may apply.


• Marriage Penalties eliminated permanently:– Increases the size for MFJ of the 15% rate

bracket to twice the 15% for filing single– Increases standard deduction for MFJ to

twice for filing single

Special Conservation Real Estate Donation extended

• For donations of qualifying real estate for conservation purposes special rules were extended through 2013.– 50% AGI deduction for non-farmers– 100% AGI deduction for farmers– 15 year carry over of unused contribution

amount.

New Medicare Surtaxes for 2013• Medicare surtax of 0.9% and 3.8% were

part of the Affordable Care Act levied to provide additional revenue for Medicare

• These may affect some agricultural producers in the near term, or, more likely in retirement.

New Medicare Surtaxes for 2013

• 0.9% is applied to wages and self-employment income once total income exceeds $200,000 for singles and head-of-households, $250,000 for married filing jointly.

• Therefore, for earnings above these thresholds, the Medicare tax is 3.8%.

New Medicare Surtaxes for 2013• 3.8% Medicare tax on investment

income for the same AGI thresholds– $200,000: singles, HoH– $250,000: married file jointly– $125,000: married filing separately

Federal Estate Tax

• The $5 million estate and gift tax exclusion is made permanent.

• The exclusion is inflation indexed– 2011 $5 million– 2012 $5.12 million– 2013 $5.25 million

Federal Estate Tax • The tax rate on taxable estates increased

from 35% to 40%; which is effectively a flat tax.

• “Portability” election is permanent– Unused portion of deceased spouse can be used

by surviving spouse• Election is made on a timely filed estate tax return

(including extensions)

Gift tax issues• Annual gift exclusion is $14,000 for

2013

• Lifetime gifts now the same value as the estate tax exclusion, $5.25 million for 2013

• A powerful tool for business succession

Contact details

• Guido van der Hoeven, Extension Specialist / Sr. Lecturer

• (v) 919.515.9071

• (f) 919.515.6268

• Email: [email protected]

Documents

Taxes for Working Forests and Tree Farms Mark Megalos, Mark Megalos,& Rick Hamilton, NC RF Extension Forester, Retired