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> For sale by the U.S. Government Printing Office Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328 ISBN 0-16-042660-X United States Department of Forest Owners' Guide to Agriculture

Forest the Federal Income Tax Service

Agriculture Handbook William C. Siegel, Retired Project Leader for No. 708 Economic and Legal Research, Southern Forest Experiment Station, USDA Forest Service, New Orleans, LA, and Attorney, and Forest Service Volunteer

William L. Hoover, Professor of Forestry, Purdue University, West Lafayette, IN

Harry L. Haney, Jr., Garland Gray Professor of Forestry, Department of Forestry, Virginia Polytechnic Institute and State University, Blacksburg, VA

Karen Liu, Taxation and Finance Specialist, Cooperative Forestry, State and Private Forestry, USDA Forest Service, Washington, DC

Harold E. Burghart, Timber Tax Law Specialist, Internal Revenue Service, reviewed the manuscript and made many valuable suggestions for improvement.

, „,,,A, National AgricuUoral Library NALBIdg , 10301 B^^yi^'l^^s'ÎsSBI

October 1995 Supersedes "Forest Owners' Guide to Timber Investments, the Federal Income Tax, and Tax Recordkeeping." Agriculture Handbook No. 681, issued July 1989. The United States Department of Agriculture (USDA) prohibits discrimination in its programs on the basis of race, color, national origin, sex, religion, age, disability, political beliefs, and marital or familial status. (Not all prohib- ited bases apply to all programs.) Persons with disabilities who require alternative means for communication of program information (braille, large print, audiotape, etc.) should contact the USDA Office of Communications at 202-720-2791. To file a complaint, write the Secretary of Agriculture, U.S. Department of Agriculture, Washington, DC 20250 or call 202-720-7327 (voice) or 202-720-1127 (TDD). USDA is an equal employment opportunity employer. Abstract

Siegel, William C; Hoover, William L.; Haney. Harry L. Jr.; depreciation, operating expenses and the passive loss rules, and Liu, Karen. 1995. Forest Owners' Guide to the Federal timber income and capital gains, government cost-share Income Tax. Agriculture Handbook 708. Washington, DC: payments, casualty losses and other involuntary conversions, U.S. Department of Agriculture. 138 p. conservation easements, installment sales, the alternative minimum tax, self employment taxes, Christmas tree produc- Updates and expands Agriculture Handbook No. 681, "Forest tion, and form of timberland ownership and business organi- Owners' Guide to Timber Investments, the Federal Income zation. Explains how to research tax questions, sources of Tax, and Tax Recordkeeping." Incorporates changes made tax assistance, and how to keep forest records. Provides since the 1987 Revenue Act. Provides a framework for summaries of selected revenue rulings. Blank tax and record analysis of timber investments and a chapter on timber tax forms, a glossary, and a comprehensive findings index are planning. Discusses Federal income tax considerations for also included. timber including: capital costs, reforestation tax incentives.

Ill Table of Contents

Chapter I. Introduction 1 Establishment of Accounts 18 Purpose 1 Land Account 18 Sources of Assistance 1 Depreciable Land Improvement Account 18 Internal Revenue Service Review 1 Timber Accounts 18 Equipment Accounts 19 Chapter II. Timber Investment Considerations 3 Reforestation Tax Incentives 19 Characteristics of a Timber investment 3 Amortization 24 Risk 3 The Credit 25 Investment Expenditures 4 The Section 179 Deduction and Depreciation 25 Land 4 Section 179 Deduction 25 Merchantable timber 4 Depreciation 25 Annual operating and management expenses 4 Operating Expenses and Carrying Charges 27 Investment Revenues 4 The Passive Loss Rules 28 Timber sale 4 Timber Held as Part of a Trade or Business in Hunting leases 4 Which the Taxpayer Materially Participates 28 Miscellaneous revenues 4 Material Participation 28 Economic Considerations 5 Surviving Spouses 29 General Economic Trends 5 Reporting Expenses 29 Economic Decision Criteria 5 Timber Held as Part of a Trade or Business in Which Net present value (NPV) 6 the Taxpayer Does Not Materially Participate 29 The benefit/cost ratio (B/C) 6 Timber Held as an Investment 29 Internal rate of return (IRR) 6 Management Costs 29 Equal annual equivalent (EAE) 6 Taxes 30 Timeline 6 Interest 30 A Forest Investment Example 6 Reporting Expenses 30 Summary 9 Chapter VI. Income Considerations 31 Chapter III. Tax Planning 1 Timber Sale Receipts 31 The Planning Team 1 Determining the Amount of Gain or Loss 31 Developing an Integrated Plan 1 Costs of Sale 31 Introduction 1 Adjusted Basis 31 Advantages of Timber Investments 1 How to Recover Your Basis 31 Estate Planning Role 1 Recovery of Basis-Disposal of Standing Timber.... 31 Planning Implications 12 Recovery of Basis-Cutting of Standing Timber 34 Substantial Initial Investment 12 Determining the Kind of Gain or Loss 34 Long Preproductive Period 13 Capital Gain Status Is Still Important 34 Tax Considerations When Timberland Is Acquired 13 Capital Gains from Timber Transactions 35 Tax Considerations When Selling Timber 13 Primary Purpose for Holding the Timber 35 How the Timber is Disposed of 35 Chapter IV. General Tax Considerations 15 How Long the Timber Has Been Held 35 Types of Forest Ownership and Operation 15 Sale of Standing Timber for a Lump Sum 36 Purpose for Holding Timber 15 Disposal of Standing Timber With an Economic Personal use : 15 Interest Retained (Section 631(b)) 36 Investment 15 The Cutting of Standing Timber With an Election To Business 15 Treat as a Sale (Section 631(a)) 38 Active business interest 15 Government Program Payments 40 Passive interest 15 Determining the Excludable Amount 41 Types of Taxpayers 15 Including Cost-share Payments in Gross Income.... 42 Structuring Your Timber Activities 16 Recapture Provisions 42 Other Timber-Related Receipts 42 Chapter V. Cost Considerations 17 Information Returns 42 Capital Costs 17 Original and Adjusted Basis 17 Chapter VII. Casualties, Thefts, and Condemnations 43 Purchased Assets 17 Discussion Limited to "Timber" 43 Inherited Assets 17 Normal Losses Not Deductible 43 Assets Received by Gift 17 Noncasualty Losses 43 Other Types of Acquisition 17 Casualty Losses 43 Allocation of Original Basis 17 Disease or Insect Infestation 43 Drought Loss 43 Escrow Accounts ^^ Loss of Potential Income Is Not Deductible 43 Electing Out ^^ Combinations of Factors 43 Unstated Interest and Imputed Interest ^^ Salvage Requirement 44 Reporting Installment Sales Determining the Amount of Deductible Loss 44 Sales to Related Parties ^^ Determining Volume of Timber Destroyed 44 Alternative Minimum Tax Determining Basis of Timber Destroyed 44 Alternative Minimum Tax Calculation ^^ Year of Deduction 44 Self-employment, Social Security Tax ^^ Destruction of Unmerchantable Timber 44 Treatment of Spouses ^^ Buildings and Equipment 45 Excluded Income Items ^ Determining the Decrease in Fair Market Value 45 Christmas Tree Growers ^ Theft Losses 45 Forest Products ^^ Year Deducted 45 Cost-Share Payments ^^ Reduce Theft Loss by Anticipated Recovery 45 How To Calculate Self-Employment Tax 56 Multiple Damages 45 Including Timber Gains In Self-Employment Income Condemnations 45 To Guarantee Benefits ^^ Condemnations for Right-of-Way Easements 46 Employment Status ^° Basis for Figuring Gain or Loss 46 Recovery of Expenses 46 Chapter X. Christmas Tree Production 59 Casualties and Thefts 46 General Considerations 59 Condemnations 46 Establishment Costs 59 Postponing Gains From Involuntary Exchange 46 Operating Expenses and Carrying Charges 59 Determining the Gain 46 Uniform Capitalization Rules 59 Requirements to Postpone Gain 47 Timber Sale Income 59 Basis of Replacement Property 47 Section 1221 59 Reporting Gains and Losses From Casualties, Thefts, Section 631(b) 59 Condemnations, and Non-casualty Losses 47 Section 631(a) 59 Casualties and Thefts 47 Making the Election 60 Reporting Gain or Loss-Property Held for The Computation 60 1 Year or Less 47 Partnership Considerations 60 Reporting Gain or Loss-Property Held for More Determination of Fair Market Value 60 than 1 Year 47 Choose and Cut Operations 61 Reporting Gain or Loss From Income Producing Property 47 Chapter XL Form of Timberland Ownership and Condemnations 47 Business Organization 63 Property Held for 1 Year or Less 47 Basic Ownership Considerations 63 Business or Investment Property Held for More Sole Ownership 63 Than 1 Year 47 Co-ownership 63 Property Held Primarily for Sale 47 Tenancy in common 63 Property Held for Personal Use 48 Joint tenancy 63 Non-casualty Losses 48 Tenancy by the entirety 63 Life Estates 63 Chapter VIIL Tax Implications of Forest Stewardship 51 Community Property 63 Introduction 51 Business Management Organization 63 Tax Law Keyed to Production of Income 51 Partnerships 63 Conservation Easements 51 Unlimited liability 64 Qualifications for Charitable Deduction of Minors as partners 64 Conservation Easement 51 Partnership taxation 64 Qualified organization 51 Limited Partnerships 64 Conservation purpose 51 Corporations 64 Qualified real property interest 52 Corporate taxation 64 Valuation of Donation 52 Subchapter S Corporations 64 Tax considerations 64 Chapter IX. Other Tax Considerations 53 Limited Liability Companies 64 Installment Sales 53 Income tax features 64 Introduction 53 Other Tax Entities 65 Calculating Installment Sale Income 53 Gross Profit Percentage 53 Chapter XII. Researching a Tax Question and Selling price 53 Appeals Procedures g? Adjusted allowable basis 53 Statutory Law g? Payments 53 Administrative Law 57

VI Revenue Rulings 67 Logging roads, permanent vs, temporary, General Counsel Memoranda 67 investment credit 91 Revenue Procedures 67 Logging roads, depreciation 91 News Releases, Notices, and Announcements 67 Long-term contracts, royalties vs. rent 91 Private Letter Rulings 68 "Purchaser credit" road construction contract. Technical Advice Memoranda 68 Forest Service 91 Case Law 68 Reforestation, replacing dead seedlings 91 Federal Court System 68 Reforestation 91 Tax Court 68 Reforestation, payments under forestry District Courts and Claims Court 68 incentives program 91 Circuit Courts of Appeals 69 Reforestation expenditures 92 U.S. Supreme Court 69 Cost sharing, payments under stewardship Interpreting Case Law 69 incentive program 92 Audits and Appeals 69 Capital Gains 92 How Returns Are Selected for Examination 69 Cutting contract, "contract right to cut" defined 92 The Examination Process 69 Cutting contract, contract right to cut, future right.... 92 Appeals Within the 1RS 70 Contract cutting, road credit 92 Appeals to the Courts 70 Christmas trees sold on "choose and cut" basis 92 Claims for Refund 70 Cutting contract, fair market value of timber cut 92 Additional Information 71 Cutting contract, payment forfaiture to cut 92 Example of Tax Research 71 Cutting contract, quantity first determined, holding period 92 Chapter XIIL Sources of Tax Assistance 73 Cutting contract, quantity first determined, 1RS Publications 73 holding period 92 Commercial Tax Service 73 Default of performance bond 92 Other Sources 73 Disposal, expenses for 92 Current Developments 73 Disposal, economic interest retained 92 Guidebooks 74 Holding period 93 Holding period 93 Chapter XIV. Forest Records 75 Long-term contract, capital gains vs. ordinary Tax Purposes 75 income 93 Management Information 75 Long-term contract, unstated interest 93 Accounting Methods 75 Long-term lease, lump sum payment 93 Recordkeeping Systems 75 Pulpwood from tops and limbs of sawtimber trees .. 93 Shoe Box 75 Right to cut and remove for landowner 93 ATree Farm Journal 75 Timberland, sale of, used in trade or business 93 A Tree Farm Journal With Accounts 76 When "cut" 93 Capital Accounts 76 Timberland tracts, deeds in escrow, holding period. 93 Land account 76 Tree stumps, investment property 93 Timber account 76 Involuntary Conversions 93 Premerchantable natural growth timber 76 Casualty loss, deduction limited to basis 93 Reforestation subaccount 76 Casualty loss, insect 93 Amortization of reforestation 76 Casualty loss, partial damage 94 Depreciation accounts 76 Casualty loss, nonrecognition of gain 94 Expense Accounts 76 Losses, timber in trees killed by insects 94 Capital Income Accounts 77 Losses, seedlings killed by drought 94 Ordinary Income Accounts 77 General Business Accounts 77 Appendix IL Index and Findings List 95 Comprehensive Example XIV-1 78 Part A: Index 95 Records for a Tree Farm Purchase 78 Part B: Findings Lists 112

Glossary 87 Appendix III. 1RS Form T (Timber) 121

Appendix I. Summaries of Selected Revenue Rulings .... 91 Appendix IV. Forms for Recording Timber Transactions. 129 Basis and Depletion Allowance 91 Christmas trees, capital and operating Index 137 expenditures 91 Christmas trees, capital and operating expenditures 91 Cutting contract, advanced royalties 91

VII List Of Tables

Table 11-1-Transactions for a Forest Management Example in the South. Per Acre 7

Table ll-2-Cash Flows With Inflation and Taxes for the Investment Example, Per Acre 8

Table ll-3-Analysis of the Forestry Investment Example, Per Acre 9

Table V-1-Recovery Periods by Type of Property Under the General Depreciation System of Section 168 of Internal Revenue Code 26

Table VI-1-How Noncorporate Taxpayers Are Currently Taxed 35

Table VI-2-How Corporate Taxpayers Generally Are Currently Taxed 35

Table XIV-1-Forever Green: Tree Farm Accounts 11

Table XIV-2-Summary of Cruise Reports for Forever Green Tree Farm and Lonesome Pine Tree Farm Purchases ...79

Table XIV-3-Allocation of Forever Green Tree Farm Assets to Capital Accounts 79

Table XIV-4-Forever Green Tree Farm: Reforestation Tax Credit and Amortization Schedules 80

VIII List Of Figures

Figure 11-1-Timeline for a Timber Investment, Shown on a Per-Acre Basis in 1994 Dollars 5

Figure lll-1-Timing of Investment, Annual Management Expense and Harvest Revenue 12

Figure V-1-Schedule B of Form T (Timber) 20

Figure V-2-Schedule C of Form T (Timber) 22

Figure VI-1-Schedule F (Form T): Capital Returnable Through Depletion 32

Figure VI-2-Schedule C of Form T (Timber) 33

Figure VI-3-Schedule F (Form T): Capital Returnable Through Depletion 37

Figure VI-4-Schedule D (Form 1040): Capital Gains & Losses 37 Figure VII-1-Schedule F (Form T): Capital Returnable Through Depletion 49

Figure VII-2-Schedule F (Form T): Capital Returnable Through Depletion 49

Figure XIV-1-Forever Green Tree Farm: Journal 81

Figure XIV-2-Forever Green Tree Farm: Land Account.... 84

Figure XIV-3-Forever Green Tree Farm: Merchantable Sawtimber Account-Volume 84

Figure XIV-4-Forever Green Tree Farm: Young Growth Account 84

Figure XIV-5-Forever Green Tree Farm: Depreciable Land Improvement 85

Figure XIV-6-Forever Green Tree Farm: Merchantable Sawtimber Account (Value) 85

IX List Of Examples

Example V-1 18

Example V-2 19

Example V-3 25

Example V-4 25

Example V-5 27

Example V-6 30

Example VI-1 31

Example VI-2 34

Example VI-3 36

Example VI-4 39

Example VI-5 41

Example VI-6 41

Example VII-1 44

Example VII-2 44

Example VII-3 45

Example VII-4 45

Example VII-5 46

Example VII-6 48

Example VIII-1 52

Example IX-1 53

Example X-1 60

Example X-2 61 Chapter I. Introduction

Purpose purposes. Therefore, the section on recordkeeping has been retained to show how to record timber-related transactions. The purpose of this handbook is to encourage good forest Forms are provided for recording expenses and income. management by presenting methods of analyzing forestry investments, and by explaining the Federal income tax as it The chapter on researching tax questions is intended to pertains to timber and timber transactions. It also provides a assist you or your tax advisor in understanding the relation- system and blank forms to enable you to keep the necessary ship between statutory and administrative law. Audit and records for tax purposes and to assist you in more effectively appeal procedures and how you take your case to court if you managing your timber investment. This publication is a major disagree with the Internal Revenue Service (1RS) are revision of Agriculture Handbook 681, Forest Owners' Guide explained. A comprehensive example explains tax research to Timber Investments, the Federal Income Tax, and Tax procedures. Appendix I summarizes pertinent revenue rulings Recordkeeping. It updates the previous publication for dealing with timber. Appendix II provides a detailed index and changes made by legislation passed after the 1987 findings list for researching tax questions. Appendix III Revenue Act, and for administrative changes promulgated provides a tax form relevant to timber transactbns. Appendix IV through 1994. provides forms for recording your timber transactions.

Since there is once again a differential in tax rates on long- Sources of Assistance term capital gains and ordinary income for certain noncorporate taxpayers, the section on timber capital gains Chapter XIII lists sources of tax assistance. Local offices of has been revised. The passive loss section has also been the Internal Revenue Service can supply taxpayer publica- modified to reflect recent administrative developments. New tions to answer most questions you will have about income chapters on Christmas tree taxation, tax implications of forest taxes. Foresters can provide assistance in determining timber stewardship, and forms of business organization and values, establishing volumes, and developing management ownership have been added. There are new sections on the plans. You may wish to consult an accountant or attorney for income tax aspects of the employee-employer-independent the application of the law to your particular facts and circum- contractor relationship, information returns, and costs of sale. stances, especially when the dollar amounts involved are The social security/self-employment tax section has been large or there is a particular tax problem. updated. As with the previous edition, there is a chapter on timber investments, in order to place timber income tax Internal Revenue Service Review considerations in perspective with the total forestry investment. This publication has been reviewed by the Internal Revenue Service, principally by its timber tax law specialist. It is not, The primary purpose of the handbook is to provide in one however, to be construed as an official interpretation of the place the relevant information for analyzing a timber invest- Internal Revenue Code or income tax regulations. It is ment and the Federal income tax law associated with the intended to serve only as a guide for you and your tax investment. It does not provide guidance in establishing or advisor. Although the information in this publication is based managing a forest stand. That information is available from on current law and regulations, many aspects of newer law State forestry agencies, the USDA Cooperative Extension are under review by the 1RS. and new regulations will be System, private forestry consultants, and industry foresters. published as appropriate. You should consult the most current information for your individual case as outlined in Good records are necessary for both effectively managing a Chapter XII, "Researching a Tax Question." The information timber enterprise and reporting income and expenses for tax in this publication is current as of January 1995. Chapter II. Timber Investment Considerations

Is forestry a good investment? Most forest landowners would be acquired in sizes to meet the needs of most investors. like to think so. Generally, growing timber can be a profitable Purchases can range from a few acres to thousands of enterprise; however, the final answer depends on the facts acres, with timber age classes ranging from seedlings to and circumstances in each case. The rewards from a forestry mature trees. investment often involve more than financial returns, includ- ing the satisfaction of ownership and a sense of pride from Risk good stewardship of the resource. Such intangible benefits, which do not show up on the balance sheet as additional Timber owners face a variety of risks that do not affect more revenue, may help explain why owners are willing to hold conventional investments. Furthermore, timber resources are timber properties that are not competitive financially. It is generally exposed to risks for a much longer time period than assumed in this chapter that you are interested in the are more conventional investments. A wildfire, for example, economic returns associated with forestry management. Its poses a threat to young plantations and to naturally grown purpose is to describe objective methods of evaluating conifer stands until they reach sufficient size for crown forestry investment opportunities on your property. These closure. Thereafter, the risk diminishes greatly with age methods will be illustrated for a managed loblolly pine stand except where drought conditions and/or heavy buildups of typical of the Southeastern United States. fuel threaten a catastrophically hot fire. Hardwoods are generally at less risk from fire than conifers due to different Characteristics of a Timber Investment fuel and site conditions.

Timber is a unique investment with several characteristics Adverse weather poses additional risks for forestry invest- that are not typical of normal business situations. First, and ments. Drought can kill seedlings established by artificial most conspicuous, is the long growth (investment) period. methods such as seeding or planting. Timber mortality occurs Natural stands of southern pine frequently require an in heavily stocked stands of all ages that are subjected to investment length of 45 to 60 years from seed to harvest, a drought stress. Modification of certain cultural practices may period known as the rotation. Eastern hardwoods may need be required for growing timber in ice, snow, and sleet belts. 60 to 80 years to produce quality sawtimber products. Many These conditions may also restrict the range of plantation- western species also require long rotations when managed in grown species. A moderate amount of destruction is caused natural stands. On the other hand, intensive management of annually by windstorms and tornados. planted southern pine shortens the investment horizon to approximately 25 to 35 years depending on site productivity, Both disease and insect pests are generally bad, and can cultural practices, and markets. Similarly, investments in cause problems for trees of all ages. Disease ranks as an intensive management shorten the rotation for hardwoods, insidious risk for forestry investments because of the difficulty mixed pine-hardwoods and western conifers; however, the of detection. If ignored substantial problems can develop. investment length is still long. Energy (fuelwood) plantations, Examples include fusiform rust, blister rust and various forms which have projected harvest cycles of 5 to 15 years, and of root disease. For timber investors the emphasis should be Christmas trees, which typically range from 4 to 12 years in on prevention and detection. Certain insects pose a hazard in age at harvest, are exceptions. These opportunities are all life stages of trees. Southern and western pine beetles, regionally important, but account for only a relatively small and the spruce budworm are insects that typically respond to share of the country's overall forest potential. growth stress in maturing stands, especially those stands with high stocking density. Some insects attack regeneration The forest resource produces many benefits in addition to while others attack stands in intermediate stages of develop- wood products. Among the multiple outputs that accrue to ment. For example, the gypsy moth attacks timber in any woodland landowners are wildlife— both game and nongame stage of development, and the risk of attack is not considered species—natural beauty, outdoor recreation, and quality to be a function of time. As with diseases, the key to minimiz- water. With the exception of hunting leases, owners rarely ing insect outbreaks is prevention and detection. receive monetary returns from these outputs. Although timber is subject to the same market risks as other The harvest timing for timber products is more flexible than investments, the risks are exacerbated by the long invest- that of annual crops. A harvest schedule can be accelerated ment horizon. The relative values of various species change or postponed by several years, in most cases, and this gives over time in unexpected ways. Costs and prices are affected the timber owner the opportunity to coincide the harvest with by expected future supply and demand, whims in consumer personal income needs, or to wait for a more favorable price preferences, technological change, and public policy. situation. Timber owners can plan to sell different products— Regional impacts that must be considered include the including firewood, pulpwood, chip-n-saw, sawtimber, and availability of local timber markets and environmental veneer logs—depending on market conditions and price constraints. relationships. Within limits, and with patience, timberland can and Investment Expenditures Annual operating and management expenses—'"Ordinary necessary" forestry management expenses are operating The way that investment expenditures are handled in an costs rather than capital expenditures. Their income tax analysis depends on whether they are classified as capital treatment will depend on the classification of the owner expenditures, or as operating costs. A more detailed explana- activity under the passive loss rules as discussed m gre tion of the tax treatment of both capital expenditures and detail in Chapter V. Generally, the impact of the P^^^'^^ ^^ operating costs is found in Chapter V. rules on investment returns depends on when ^P®''^^'"; „ deductions are allowed to be taken. In Figure 11-1. ^^^¡¡^^^ Land—The costs of forest land and permanent improvements recurring property taxes and management costs are s on the land are capital expenditures. They must be consid- as being currently deductible for this particular '"^^^^^fn Lar ered when forestry investments are compared with alternative example. Similarly, the timber stand maintenance ccsi in yea uses of investment funds (e.g., forestry vs. common stock). In 10 and the chemical release cost in year 3 are^s'^gie the example shown in Figure 1, the purchase price for expenses that are assumed to be currently deductible. cutover land is reported at the beginning of the investment period at $300 per acre (year 0). Note that the terminal value Investment Revenues of the land and permanent improvements is also shown as a revenue at the end of the investment period (year 34). All revenues that accrue to the land as a result of the landowner's investment and management activities should be In analyses of land use alternatives, it is appropriate to included in the accounting. exclude the cost of land if it is owned and common to both alternatives under consideration. Examples include compari- r/möersa/e—Timber sales are normally the primary revenue sons of forestry vs. agricultural uses, intensive forestry sources for a forestry investment. Even-aged timber manage- (planting) vs. extensive forestry (natural regeneration), and ment cycles often include one or more intermediate harvests forests managed exclusively for timber vs. management and a final regeneration hangest. For example, the intermedi- exclusively for wildlife. ate thinning at age 20 (Figure 11-1) produces revenue of $248 per acre (10.8 cords x $23 per cord). For an investment The investment evaluation should consider the total acreage, analysis, future revenues are based on volume projections not just the net productive acreage, in orderte accurately coupled with price information that may be obtained from a assess the expected returns. Typical tree farms may have an variety of sources. In the South, prices are reported quarterly much as 25 percent or more of their surface area in roads, in Timber Mart-South as well as by several State services rights-of-way, water, and other nonproductive acres. such as the Louisiana Forest Products "Quarterly Market Report." In the Midwest, the Wisconsin "Forest Product Price Important considerations when purchasing forest land include Review" gives price information for Wisconsin. Price informa- productivity (site index), operability (slope, soil condition, tion is also available in other regions from the State etc.), accessibility (the nearness of roads), location, and Forester's office or the State Cooperative Extension Service. current timber stocking. Note, however, that care must be exercised in applying Merchantable timber—Timber acquisition and establishment reported prices to your particular timber investment. The costs are also capital expenditures. An adequate number of influences of topography, timber quality, competition among trees of desirable species (growing stock) must be present to prospective markets, and several other factors all have a realize the productive potential of the investment. If trees bearing on price. exist at the time of acquisition, as either merchantable timber or as young growth or both, a portion of the acquisition basis Hunting teases—Hunting leases are one of the most impor- must be proportionally assigned to each according to their tant nontraditional sources of revenue from the forest. Annual relative fair market values (see Chapter V, page 18). The revenues may range from $1.00 to $10.00 or more per acre- capital costs of establishing a timber stand, either following a depending on location, size of the tract, and quality of the han/est or in the conversion of open land, include the costs of hunting. Additional capital outlays and management expendi- site preparation, planting or seeding, and release of the tures may be necessary to obtain the highest lease rates. seedlings from competing vegetation as necessary for When multiple uses such as hunting leases are added to the seedling sun/ival. forest investment, the benefits should be carefully weighed against the added cost outlays and any foregone timber Future timber products and volumes should be projected income. Hunting lease revenue is illustrated in when analyzing the investment. Data for making projections Figure 1 with hunting income shown from years 0 through 34 for most major species are available from timber yield tables at $4.00 per acre per year. This amount is based on the published by land-grant universities and State forestry assumption that the timber stands involved provide the organizations. Yield tables are also published regionally by diversity of age classes necessary for quality wildlife habitat the USDA Forest Service and the Tennessee Valley Authority and hunting. This lease income is treated as ordinary income in the South. In addition, microcomputer software is available for Federal income tax purposes. from major land-grant universities for most of the commer- cially important timber species. These programs make it Miscellaneous revenues—Other income from the forest may possible for you to simulate a wide range of expected include recreational fees for camping, livestock grazing fees, outcomes based on proposed or alternative operational and mineral revenues. Intensive recreational uses often management decisions. involve modifications of forestry practices and correspondingly Figure il-1—Timeline for a Timber investment, Shown on a Per-Acre Basis in 1994 Dollars

Income Commercial Sell land: +300, thinning: Harvest: +$2,386 +$248 +$4, (Hunting lease 4 i LL

5 10 15 20 25 30 34 1$40, Chemical release _-$125, Site preparation î-î$20, Timber stand maintenance _-$65. Plant Costs -$300, Buy land

^-$2, Property taxes ^-$5, Management costs

increased costs. Similarly, mineral revenues may be substan- (1994) dollars. The basis is the capitalized value (book value tial; however, such activities can involve sharply increased is another name) of the assets as purchased, inherited, or costs and/or impair timber site productivity. These high-risk received by gift. Recovery of basis in timber for income tax opportunities should be analyzed separately from normal purposes generally is done by a process termed cost forestry investments on a case by case basis. In certain depletion. The basis (in today's dollars) is subtracted from areas tipping (cutting boughs for garlands and wreathes), timber revenue in future (inflated) dollars at the time of timber pine straw, nuts, and maple syrup generate additional disposal. The result is a diminished tax benefit from capital income. Most miscellaneous revenue is treated as ordinary recovery overtime. Therefore, after-tax analyses should be income for Federal income tax purposes. made in current terms (i.e., with inflation included) to avoid an inflation-induced overstatement of capital recovery benefits. Economic Considerations Since all cash flows will reflect inflationary projections, it is imperative that the discount (interest) rate used for the It is assumed here that your objective as a forest landowner analysis include a similar expectation factor for inflation. In is to analyze the financial return from a timber investment. summary, both elements of the analysis—i.e., cash flow and There is no intent to evaluate personal nonf inancial discount rate—must be kept in comparable terms (with or objectives. without inflation; and before- or after-tax) for reliable results.

An individual's marginal income tax rate affects after-tax cash Most forestry costs change at the rate of inflation in the flows. The marginal tax rate (i.e., the rate applicable to the economy; however, stumpage prices may increase (or last dollar earned) is the appropriate one to use in the decrease) at rates exceeding (or less than) inflation when investment analysis. The noncorporate marginal tax rate for supply/demand relationships change. These differential price long-term capital gains revenue is capped at 28 percent. trends can cause miscalculations in an investment analysis. Real (exceeding inflation) price appreciation—or price When Federal or State cost-share payments are available for depreciation as the case may be—for some products such as forestry practices, tax treatment alternatives should be southern pine and Douglas-fir sawtimber stumpage has considered. See Chapter VI for a detailed discussion of these received much attention, but other product prices such as provisions. The net effect of the cost-share payment on after- those for pine and hardwood pulpwood, and equipment costs, tax income should be incorporated in the analysis. The have also been affected. Predicting the future is always benefits of the reforestation amortization deductions and uncertain and hazardous, so the best information available credit (discussed in Chapter V) should also be incorporated for projecting real changes in cash flows should be used. into the cash flows under consideration where appropriate. Economic Decision Criteria General Economic Trends The analysis of long-term forestry investments requires taking Inflation, through changes in the price level, affects all future the time value of money into account. Discounted cash-flow cash flows. For example, land, timber, and equipment techniques using compound interest satisfy that requirement. acquisition costs; and reforestation establishment costs are One of the most important considerations affecting invest- capitalized into the basis of the respective accounts in today's ment results is the choice of a discount or interest rate (these terms are sometimes used interchangeably). The investor is conditions where: (1) projects have different lives. (2) the comparing the returns from timber with the expected returns scale of one project is larger than that of others, and (3) cas from the best alterative opportunities available. These are flows of one project increase over time while the others referred to as the investor's alternative rates of return. The decline. In such instances you should select the criteria tha investor's marginal tax rate is used to adjust alternative rates best meet your needs, or possibly use other factors in of return to an after-tax basis for analyzing after-tax cash weighing the project's benefits. flows. A number of microcomputer programs are available to Four decision criteria are commonly used by investors to woodland owners for analyzing forestry investments, tx- determine if independent investment projects should be amples include the Quicksilver Forestry Investment Anaiys s undertaken. The following paragraphs present only a brief Program and TWIGS, both available from the USDA Forest overview of these four criteria. A comprehensive treatment of Service, and the Tennessee Valley Authority's Yield Plus the subject is found in Essentials of Forestry Investment Program. These programs generally compute the decision Analysis by Gunter and Haney, discussed in Chapter XIII. criteria noted above as well as others. Some packages also include growth and yield simulators for a variety of species. Net present value (NPV)-—M\ costs and revenues are Again, good judgement should be exercised in fully under- discounted to the present at the investor's alternative rate of standing the assumptions inherent in the results of any return. If the net result is positive, an investment should be model's output. undertaken. Among mutually exclusive alternatives (those in which the selection of one precludes selection of others) of Timeline similar risk, the investment with the highest NPV should be selected. At the investor's alternative rate of return, the NPV A timeline is a diagram that helps you to visualize both the is the contribution to his (her) net wealth from undertaking the nature and the distribution of cash flows from the forestry project. project over the investment period (see Figure 11-1). Cost cash flows are shown with a minus below the time-line. The benefit/cost ratio (B/C)—All costs and revenues are Revenue cash flows are shown with a plus above the time- discounted to the present at the investor's alternative rate of line. The cash flows may be single amounts that occur only return and the ratio of discounted revenues divided by once in the investment period. An example is the timber stand discounted costs is calculated. Projects with B/C ratios maintenance cost in year 10 of $20 per acre. Cash flows may greater than 1:1 are profitable; projects are selected on the also be periodic amounts that occur annually or at longer basis of the highest B/C ratio. The B/C ratio is an expression intervals. The property tax of $2.00 per acre is an example of of the return per dollar invested in a project for an investor's an annual cost that recurs throughout the investment period. given alternative rate of return. A review of the time-line should ensure that all cash flows that have a bearing on the analysis are properly recorded. Internal rate of return (IRR}—\RR is the average compound interest rate that will be earned over the investment period. It A Forest Investment Example is found by calculating the discount rate that makes the sum of discounted revenues and discounted costs equal to zero The procedure for evaluating an investment opportunity will (i.e., the NPV will be zero). If the IRR exceeds the alternative be illustrated with an example intended to be typical of a rate of return, sometimes called the hurdle rate, the project management alternative that could be practiced in the should be undertaken. Mutually exclusive projects should be Southeastern United States. Assume that a property for sale selected on the basis of the highest IRR, other things being consists of marginal agricultural land that has been idle for equal. IRR is an expression of the rate of return for capital several years. It would be similar to land retired under the invested in a project. Conservation Reserve Program (CRP). The forestry potential of this acreage is shown with all costs and returns on a per Equal annual equivalent (EAE)—7he EAE spreads the acre basis. benefits and costs of an investment over its useful life in the same way that installment payments spread the cost of a The initial investment in 1994 dollars per acre includes a loan over the payback period. Projects with unequal lengths beginning investment in land at $300 (year 0) plus site can be compared using EAE's because infinity is the as- preparation at $125 and planting at $65, both completed in sumed investment horizon. This permits comparisons among the first year. These are all capital expenditures that must be projects of differing lengths, for example multiyear projects recorded in the taxpayer's books as basis for later recovery such as sawtimber versus pulpwood rotations, or multiyear as explained in Chapters VI and X. An herbicide application projects versus annual crops. Independent projects with at $40 to control competing vegetation and thus improve positive EAE's should be undertaken. For mutually exclusive plantation growth, is incorporated in year three. In addition, projects, the one with the highest EAE should be selected, annual property taxes of $2 and annual management costs of other things being equal. $5 are included. A further treatment at year 10 costing $20 is applied for timber stand maintenance. These are assumed to Generally, the four criteria will rank investment projects be currently deductible expenses for income tax purpose as similarly. However, they may rank projects differently under discussed in Chapter V. The revenue for this example in 1994 dollars includes hunting Forestry investments are very sensitive to the discount rate lease income of $4 per acre (ordinary income) in years 1 because of the long time period between planting and through 34, and a land sale of $300 in year 34. Timber harvest. For after-tax analyses, the correct discount rate is revenue includes thinning income of $248 at age 20 and the after-tax rate based on your alternative rate of return. If harvest income of $2,386 at age 34 (see Table 11-1). All cash the next best alternative is a tax-free investment, such as a flows are adjusted for a 3-percent general inflation rate. In municipal bond, then the interest rate is used without addition, timber revenues are adjusted for a one-percent real adjustment as shown in Table 11-3 for the 10 percent price increase (see Table 11-1). Prices are assumed to be $23 discount rate. per cord for standing pulpwood (5-9 inches dbh), $56 per cord for chip-n-saw (10-12 inches dbh), and $83 per cord If the next best alternative is an investment, such as a equivalent for sawtimber (13 inches and above dbh) based corporate bond, that yields 10 percent annually with taxes on the Timber Mart-South regional average for the first subtracted before compounding, the correct discount rate is quarter 1994. Expected price appreciation is based on USDA 7.2 percent, after-tax [10 percent x (1 - .28 assumed tax Forest Service projections of future price changes adjusted rate)]. Alternatively, if the next best alternative is an invest- downward by 1 percent. Timber and land revenues are ment such as an individual retirement account (IRA), certain assumed to qualify for long-term capital gains treatment. saving bonds, or an alternative timber investment, where taxes are deferred until the end of the period rather than Timber yields are based on a loblolly pine growth and yield being subtracted before compounding, then the correct model for planted sites. The commercial thinning is expected discount rate depends on the length of the investment period to yield 10.8 cords per acre. The harvest clearcut at age 34 and when costs are incurred and revenues received. Assum- yields 6.8 cords of pulpwood, 29.0 cords of chip-n-saw, and ing an initial investment, 10 percent interest, and a 28 percent 7.3 cord equivalents of sawtimber, per acre. tax subtracted at the end of 34 years, the approximate discount rate would be 8.942 percent. The landowner-taxpayer is assumed to be married, filing jointly, and in the 28 percent marginal tax bracket (i.e., 1994 The three discount rates discussed above are used to show taxable income is over $38,000 but not over $91,850); the the sensitivity of the analysis to the interest rate used. As the long-term capital gains tax rate is also capped at 28 percent. discount rate falls it is less expensive to carry the timber A summary of cash flows is shown in Table 11-2. The example investment; therefore, the returns to timber projects improve is analyzed with the reforestation amortization and investment with lower rates. The net present value, after-tax, in this tax credit options incorporated as discussed in Chapter V. No example is $256 at a 7.2 percent discount rate. It declines to - cost-share payments are included in this example, although it -$37 for the deferred, after-tax interest rate of 8.942 percent, would be a straightforward procedure to incorporate them in and to -$150 at a 10 percent discount rate (Table 11-3). Only the analysis. projects with positive net present values are acceptable. Therefore, you would not make this investment if your It is helpful to organize the cost and return information on a alternative rate exceeds 8.66 percent, after-tax, and you base timeline as shown in Figure 11-1 to be certain that the timing the decision strictly on financial returns. The 8.66 percent rate and amount of cash flows are properly accounted for in the is the IRR at which the NPV becomes zero as is discussed in analysis. The calculation of the decision criteria can be done the following paragraph. with a hand calculator or the data can be entered in a microcomputer software program to analyze the investment The internal rate of return is the calculated rate that a timber as described above. investment earns. It is therefore independent of the discount

Table 11-1—Transactions for a Forest Management Example in the South, Per Acre

No. Activity Year(s) Current Rate of Quantity value change* $/unit %/year 1. Buy land 0 -300 0 1.00 acres 2. Site preparation 1 -125 0 1.00 acres 3. Planting 1 -65 0 1.00 acres 4. Properly tax 1-34 -2 0 1.00 acres 5. Management fee 1-34 -5 0 1.00 acres 6. Herbicide 3 -40 0 1.00 acres 7. TSI 10 -20 0 1.00 acres 8. Use fees 1-34 4 0 1.00 acres 9. Commercial thinning 20 23 1 10.8 cords 10. Final harvest (pulpwood) 34 23 1 6.8 cords 11. Final harvest (chip-n-saw) 34 56 1 29.0 cords 12. Final harvest (sawtimber) 34 83 1 7.3 cords 13. Land sale 34 300 0 1.00 acres * All cash flows are adjusted for the general level of inflation (3 percent in this example) plus the differential rate of change shown here. Table 11-2—Cash Flows With Inflation and Taxes for the Investment Example, Per Acre

Cost with Benefits Tax Net income Net income Year Cost inflation Benefits w/inflation effect witfi tax w/o tax

Dollars

0 -300 -300 0 0 0 -300 -300 1 -197 -197 4 4 23* -170 -193 2 -7 -7 4 4 8 5 -47 3 -47 -51 4 4 20 -39 -3 4 -7 -8 4 5 8 5 -3 5 -7 -8 4 5 8 5 -3 6 -7 -8 4 5 8 5 -3 7 -7 -8 4 5 8 5 -3 8 -7 -9 4 5 5 1 -4 9 -7 -9 4 5 1 -3 -4 10 -27 -36 4 5 9 -22 -31 11 -7 -10 4 6 -3 -4 12 -7 -10 4 6 -3 -4 13 -7 -10 4 6 -3 -4 14 -7 -10 4 6 -3 -4 15 -7 -11 4 6 -3 -4 16 -7 -11 4 6 -3 -4 17 -7 -11 4 7 -3 -5 18 -7 -12 4 7 -3 -5 19 -7 -12 4 7 -3 -5 20 -7 -12 307 555 -152 391 542 21 -7 -13 4 7 2 -4 -5 22 -7 -13 4 8 2 -4 -5 23 -7 -13 4 8 2 -4 -6 24 -7 -14 4 8 2 -4 -6 25 -7 -14 4 8 2 -4 -6 26 -7 -15 4 9 2 -4 -6 27 -7 -15 4 9 2 -4 -6 28 -7 -16 4 9 2 -4 -6 29 -7 -16 4 9 2 -4 -7 30 -7 -16 4 10 2 -5 -7 31 -7 -17 4 10 2 -5 -7 32 -7 -18 4 10 2 -5 -7 33 -7 -18 4 11 2 -5 -7 34 -7 -19 3.651 " 9.974 -2.703 7.252 9.955 * This value includes a 10% tax credit on the original cost, plus the annual expense deductions and the amortization deduction. It is based on 95% of the reforestation cost times the 28% marginal tax rate with 1/14 deducted in years 1 and 8 and 1/7 in years 2 through 7.

** All costs and revenues, including land, are increased by 3 percent annual inflation. Timber revenues are increased by an additional 1 percent real price increase.

rate. In the example, the IRR for the investment is 9.31 percent, and at the 10 percent tax-free discount rate the present value before-tax, and 8.66 percent, after-tax. For independent of benefits is $0.93 per present value dollar invested. Only projects, an acceptable IRR should exceed the investor's projects with a benefit/ratio greater than 1:1 are acceptable, alternative rate of return. For mutually exclusive projects, the so the timber investment would be accepted only if your alternative with the highest IRR after-tax, other things being decision was based on rates below 8.66 percent, after-tax. equal, would be accepted. Thus, the investment example will be an acceptable project if the landowner-taxpayer has an The equal annual equivalent shows how much the investment alternative rate that does not exceed the 8.66 percent IRR would return each year. This value is useful for comparing after-tax. timber returns with annual returns from farm crops. At a 7.2 percent discount rate, the EAE is equivalent to receiving a At a 7.2 percent discount rate, the benefit/cost ratio is 1.47:1 ; net after-tax return of $20 per year over the investment that is, the investment returns $1.47 for every $1.00 invested period, but only -$3.51 at the 8.942 percent-deferred discount in present value terms, after-tax. The benefit/cost ratio also rate and -$16 at the 10 percent rate. Only investments that declines as rates increase. At the defen-ed rate of 8.942 percent yield positive EAE's are acceptable. the present value of benefits is only $0.93 per dollar invested. Table 11-3—Analysis of the Forestry Investment Example, Per Acre

Criteria Criteria value after Tax treatment of best alternative Discount rate, after-tax 28% tax Percent Net present value 10% return with annual tax 7.200 $255.77 10% return tax deferred 34 years 8.942 (-37.13) 10% tax free 10.000 (-150.47)

Benefit/cost ratio 10% return with annual tax 7.200 1.47:1 10% return tax deferred 34 years 8.942 0.93:1 10% tax free 10.000 0.71:1

Equal annual equivalent 10% return with annual tax 7.200 20.46 10% return tax deferred 34 years 8.942 (-3.51) 10% tax free 10.000 (-15.66)

Internal rate of return (before^ax 9.31%) 8.66%

Summary Forestry investment decisions are always made on the basis of limited and incomplete information because no one can A forestry investment must be analyzed within the context of see into the future. The examples given to illustrate the your personal goals. Because these investments are long- method of analysis are valid only for the specific assumptions term, an objective decision framework that takes into account and information used here. The method, however, is gener- the time value of money is required. The investment criteria ally applicable to a wide variety of investment situations. This give appropriate decision rules for comparing alternatives, but framework should allow you to compare forestry investments the results are only as useful as the accuracy of the esti- with other investment alternatives on an objective basis if all mates of costs, revenues, and discount rates used. There- information affecting the outcomes is considered. Good fore, expected values of each economic variable should be judgment fostered by experience is essential for tempering chosen carefully. the choice of inputs and for evaluating the results while including intangibles and personal considerations. Chapter III. Tax Planning

The Planning Team expenditures must be carried in a timber account for years before being recovered. Likewise, long-term borrowing on Achieving the maximum potential from your timber property timberland is limited to institutions such as the Farm Credit requires the development and implementation of an inte- Bank (formerly Federal Land Bank) and a few insurance grated forest management, estate, and financial plan. companies that specialize in timber loans. Some commercial Depending on the complexity of your circumstances, and banks make short-term loans on timber property. your willingness to become personally involved in the timber, legal, financial, and tax aspects, you may need the technical For a given level of risk, however, timber may increase the expertise of a consulting forester, accountant, lawyer, or other return to your overall investment portfolio. Since no tax is due investment advisors. The role of each of these individuals is until gain is recognized, the law favors investments that yield discussed in the context of the planning considerations that appreciation rather than annual income. Timber provides a should be made. means of tax deferral—that is, the value accumulation through growth and product change is not recognized until Developing an Integrated Plan the timber is harvested. It appreciates in value due to growth in volume, in-growth into more valuable product categories Introduction (e.g., pulpwood into sawtimber, etc.), increase in quality, and long-run-real (in excess of inflation) price increases. Thus, The financial objective for your timber activity should be to woodlands with adequate growing stock appreciate in value maximize the after-tax return on the funds you have commit- over time and require very little management attention other ted for the benefit of whomever you desire. If your objective is than monitoring the timber stocking levels and protection from to merely enjoy the woodland, your activity most likely insects, disease, and trespass. Your forester should be constitutes a hobby and should be treated accordingly for tax routinely involved in this process. proposes. Personal enjoyment and profitability are not incompatible goals, but any expenditures you make that do Timber property may serve as an inflation hedge because it not contribute directly and materially to profitability may not provides considerable flexibility in harvest timing. This is receive favorable tax treatment. Thus, your forester should illustrated in Figure III-1 with a stand that can be harvested draft the forest management plan so that the prescriptions within 3 to 4 years prior to or after an optimum rotation recommended and their impact on profitability are clearly stated determination, with a minimum amount of foregone income and understood. Similarly, the accountant should advise on the potential (detailed discussion is found on page 12). Further- recording of expenses in your accounts so you can distinguish more, income realization can be timed to meet cash needs or between profit oriented and pleasure oriented outlays. tax considerations because, within limits, cutting can be delayed or accelerated—^thus affecting income and/or tax Tax planning does not mean tax evasion. Rather, it means liability in a given tax year. The marginal tax rates for the year arranging your affairs so that you pay only the tax required by income is shifted from and to must be considered. law, which takes into account the advantage of any conserva- tion incentives included in the law. Your accountant may For highly appreciated timber property (low basis), the suggest tax deferral, shifting of tax burdens among family recognition of income can often be deferred for income tax members, and timing of cash flows using the cash method of purposes until retirement. Short-term cash needs can be accounting as legal planning strategies to minimize your accommodated by borrowing with the woodland as collateral taxes. Your accountant and attorney should be familiar with more effectively than by a sale. Although timber is somewhat the forest management plan so that they can anticipate illiquid, it may provide a financial reserve to meet cash needs. opportunities to assist you in making favorable tax adjust- Both your forester, who can determine the optimum timing of ments in the timing of revenues and expenses. timber cutting for given assumptions about cost and rev- enues, and your tax accountant, who can advise as to the tax A consistent tax strategy is important. You should evaluate impacts of various management alternatives, should be your goals and the extent of your forest resources and decide involved in this process. if your operations constitute an investment, or if they rise to the level of a business (see Chapters IV and XI). Your Estate Planning Role accountant and attorney can assist you in making a determi- nation that best fits your circumstances. Then your records Timber can be used as the component of a portfolio designed for reporting of income and deducting of expenses should be to accumulate wealth for transfer to heirs. You may want to handled accordingly. arrange your affairs to minimize liability for estate and other transfer taxes. Thus, timberland is often a good candidate for Advantages of Timber Investments a short-term trust or intergenerational joint ownership. Forest property is also a good candidate for a family gifting program Timber investments as a rule are not tax shelters since, to reduce the gross estate value to less than the Federal among other things, you cannot deduct more than your estate tax threshold. There are also other advantages for out-of-pocket investment in the activity, in fact, many using timber as a gift. These include situations where it is

11 Figure III-1. Timing of investment, annual management expense, and harvest revenue.

Value (thousand dollars)

Curves -°- Land H LIq. -^C/l -NPV

10 15 20 25 Time (years)

Loblolly Pine on an Average Site - NPV @ 6% -- IRR @ 8.24% desired to spread income tax liability among family members. valuation and the attorney or tax accountant, or both, can Gifts, however, have one key disadvantage in addition to loss assist in making the appropriate elections. of control. Gifted property retains the donor's basis, which often is quite low, as opposed to stepped up basis for Planning Implications property passed at death. If a gift tax has been paid, the donee's basis may sometimes be increased by part of the Various timber characteristics lend themselves to specific amount paid. Your attorney and accountant should be planning implications. Deferral of income is an example. The consulted on the tax consequences of specific actions and on trees generally increase in volume (quantity) and value the overall impact on your estate planning. annually, but the increase in value is not recognized until the trees are harvested. The tax liability of a family can in many cases be minimized by shifting income from higher to lower bracket family Substantial Initial Investmenh-The acquisition of woodland members though gifts of income producing property. The generally requires a substantial initial investment with little Uniform Gifts to Minors Act facilitates income shifting. Under possibility of immediate cost recovery, unless merchantable the Act, a gift of intangibles can be made to a minor, but with timber is acquired. For example, purchase of timberland an adult serving as custodian. Usually, a parent who makes includes a bare land value at an average cost of $300 per the gift is also the custodian. State law allows the custodian acre. If not stocked, reforestation costs can vary from $100 to to manage the assets provided there is no commingling of the $300 per acre depending on site index (productivity), oper- child's income with the parent's property. Such planning is ability, and other factors. To minimize the time over which limited by the tax liability calculation for a child under the age such costs must be carried, you should ensure that the of 14. Your accountant can help evaluate the tax implications proper portion of the available basis is allocated to each of various gift alternatives. asset account (Chapter V), amortize qualified reforestation expenditures (Chapter V), and claim the reforestation Tiinberland estates may qualify for special use valuation investment credit (Chapter V). The costs allocated to timber (Section 2032A of the Internal Revenue Code) and for basis that cannot be amortized will usually be recovered only deferral and extension of estate tax payments (Section 6166). as the timber matures and is sold (see Figure III-1). Timber, as a renewable resource, can often provide funds to meet transfer tax liabilities without having to liquidate Figure III-1 illustrates several points. First, the liquidation nonrenewable family business assets. Your forester can curve shows the merchantable volume that could be har- assist in the valuation of woodland assets for special use vested over time from an acre planted to loblolly pine of

12 average productivity in the south. This particular curve You also should develop an awareness of marginal tax rates assumes that the timber brings a constant price per cord and on cash flows. Tax shifting from one year to the next has is managed on a no-thin regime. Timber production is also been limited by Congress; however, management decisions assumed to be the highest and best use for this land. Even in can often be made to alter the income/cost timing to take this simple example, timber production is a capital intensive advantage of lower marginal tax rates. undertaking that involves land, establishment costs to obtain adequate growing stock, and annual operating costs that Tax Considerations When Timberland is Acquired must be committed for long periods of time. Second, net present value (NPV) calculations at a 6 percent cost of capital It may be helpful for you to develop and maintain in your files are shown for 5-year intervals indicating for these inputs that a management plan documenting your intention to manage age 25 is an optimum rotation age. But notice that on either the property for profit, and to include an estimate of projected side of this optimum rotation the NPV deviates only moder- profit. Your forester should be able to make this projection ately. Finally, if the establishment costs and the annual costs routinely as part of the management or estate plan. Establish are compounded forward and plotted they form a cost curve accounts to which the costs of acquisition, or values associ- [see the cost/income (C/l) curve on Figure III-1]. Similarly, if ated with acquisition if the property is inherited, are allocated potential revenues are discounted backward to the beginning according to the relative fair market value of each component of the investment, subtracting the intervening annual costs of the property acquired. Do so while the information is and plotting them, the figure shows an income curve. In this readily at hand (see Chapters V and XIV). You should file for special case where the income and cost curve are plotted at property tax relief if special forest property tax laws exist in 8.24 percent, the internal rate of return (IRR) for these inputs, your State. the curves coincide. With IRR as a decision criterion the curves show that the ideal harvest timing would be at Both your forester and tax accountant should be involved in approximately 23 years of age—^the point of tangency identifying and incorporating these opportunities in ways that between the cost/income and liquidation curves. The vertical are most advantageous with regard to your long-term goals. distance between the income/cost and the liquidation curves, Your forester and accountant should coordinate the timing of gives a measure of foregone income between potential and the revenues as well as the treatment of all costs as dis- actual. It is small in the vicinity of an optimum harvest age. cussed above. Finally, planning is a dynamic activity that The figure illustrates graphically that you have a decision must keep abreast of your family situation, the economy, and window in which you can make a harvest decision that meets tax law changes. Your advisors should be included in all your personal goals with only a small sacrifice of potential phases of the process in order to help you fully realize your income. goals for your woodland property.

Good forest valuation and accounting information is neces- Tax Considerations When Selling Timber sary for effective planning. The forester can generate the valuation information, and the accountant can see that the Maximize after-tax income by taking all allowable deductions proper allocation is made to the original basis in the appropri- against timber sale proceeds. Report net timber income as a ate capital accounts. long-term capital gain if it qualifies (Chapter VI). Capital gains do not affect the amount of social security retirement received Long Preproductive Per/od—Consider structuring your timber and the self-employment social security tax is not due on the activity to allow the deduction of qualified expenses against net sale income (see Chapter IX). Consider deferring receipt other (non-timber) income where appropriate. This usually of a portion of the sale proceeds only if the resulting tax involves organizing the woodland as a business with material saving exceeds the opportunity cost of not having use of the participation on your part (Chapter V). Early payment of deferred funds (see Chapters II and IX). expenses at the end of the tax year accelerates the benefit of the deduction. Otherwise, try to acquire timberland with a good distribution of timber age classes.

13 Chapter IV. General Tax Considerations

Types of Forest Ownership and Operation are regularity of activities and transactions, and the production of income (See Publication 334. "Tax Guide for Small How you may treat the expense and income items associated Business," Chapter 1). Your relationship with any business in with your woodland depends on your purpose for owning the which you own an interest is considered to be either "active" property, your use of it, your taxpayer classification with or "passive" in nature. respect to the property, and the nature of the expense/income item itself. For example, property tax payments on Active business interest-—You are actively engaged in a nonbusiness property (personal or investment) are deductible business if you "materially participate" in conducting it. To by individual taxpayers because they are among the allow- materially participate, you must personally participate on a able itemized deductions for individuals. Property tax regular, continuous, and substantial basis in the conduct of expenditures on business property are deductible business the activity. costs. The expenses of protecting woodland from fire, however, can be deducted only if you hold the property for Passive interest—Your relationship with your trade or the production of taxable income either as an investment or business is passive if you do not materially participate in its as a business. If an individual does not materially participate operations. These distinctions are discussed in more detail in in the business, however, the passive loss rules, which are Chapter V. discussed on page 28, will apply. The determination of your primary reason for holding a Hunting lease income or other fees received for using your particular woodland property is based on all the facts and land are ordinary income under all types of ownership. circumstances related to your intended and actual use of the Income from the disposition of timber, however, may qualify property. No single factor is controlling, but your activities at for long-term capital gain treatment. Capital gain status the time of determination are very important. Because of the depends on how long you have owned the timber; how it is unique nature of most forest property, there are usually disposed of; and whether or not you hold it as an investment, elements of personal use associated with its status as either or as part of a business. See Chapter VI for a detailed an investment or a business. You should be careful to discussion of how to meet the qualifications for capital distinguish those activities associated with profit from those gains treatment. associated with personal pleasure in your recordkeeping and tax reporting. That is, you should have a clear business or Purpose for Holding Timber investment purpose for each deduction taken. Adequate records should be kept as proof. Timber property can essentially be held for one of three basic purposes, or some combination of them: Types of Taxpayers

Personal use—Property not used to produce income is The two basic types of taxpayers are individual and corpo- classed as being held for personal use. The house and land rate. An individual engaged in a business as a sole proprietor that serve as your residence is an example. Even though you reports all income except capital gains and all expenses on might expect to sell it some day for more than you paid, the either Schedule C or Schedule F of Form 1040. The net primary reason for having a residence is to give you a place income (or loss) from these forms is transferred to the first to live. Likewise, you may own forest property primarily for page of Form 1040 for inclusion in the taxpayer's gross personal enjoyment—such as for hunting, fishing, or other income. Investment income from timber is virtually always recreational pursuits; or as a second home site. capital gain.

/nv^esimen^—Woodland used to produce income may in many Although partnerships file tax returns, they are information cases be investment property rather than a business. If returns only Partnerships do not pay taxes themselves. timber production is not your principal or a major source of Information returns report the income and other tax items income, but you otherwise manage the property for the associated with the activity for the year and how these items eventual realization of a profit, you may be holding it as an are to be distributed (passed through) to the individual investment. Absentee owners often qualify as investors partners. Income from all sources is consolidated on the because their timber related activities are motivated primarily individual tax return, and the appropriate individual tax rate is by profitability rather than for other purposes. then applied to total taxable income. Note that joint ownership of property does not necessarily create a partnership for tax Business—Property is considered as held for use in a purposes. A partnership for tax purposes exists if there is the business if it is part of an activity entered into and carried out joining together of two or more persons or other legal entities for profit on a more regular basis than in the case of an to carry on a trade or business, with each contributing to the investment. In addition, you may be holding your timber venture, and each expecting to share in the profits and losses "primarily for sale" to customers in the ordinary course of a of the activity. A woodland ownership may be a partnership if trade or business. Two characteristic elements of a business its operations are treated as a partnership under the law of the State where the property is located.

15 Certain corporations may elect to be taxed like a partnership. Structuring Your Timber Activities Corporations making this election are referred to as S corporations. Those not making the election are referred to It is important for you to consider your ownership and as C corporations. financial goals, the extent of your woodland resources, and perhaps other factors before deciding which structure is best Individual taxpayers report their portion of partnership or for your woodland and on an income tax strategy. Once you S corporation income (or loss) on Form 1040, Schedule E. have made this decision, it should guide a consistent Net income (or loss) from Schedule E is then transferred to approach to recordkeeping, tax reporting, and management the first page of Form 1040 for inclusion in the taxpayer's decisions until your circumstances change. gross income. How your timber-related activities are classified is generally A new organizational structure called a limited liability dictated by their scope and nature. If you own a small company (LLC) is now possible in most States. It provides acreage and have only occasional transactions, you are most the limited liability of a corporation, and the pass through tax likely treating the activity for tax purposes as an investment. If treatment of a partnership. your holdings generate fairly regular and continuous transac- tions, your activities may constitute a business. In this case, Estates and trusts represent a special case. They may or you should evaluate which structure your business should may not pay income tax as separate taxable entities, depend- have to best achieve your objectives. In many cases you will ing on the particular circumstances involved. However, if treat it as a sole proprietorship. If your family is involved you income is retained by either an estate, or a trust, a fiduciary may want to execute a partnership agreement, incorporate, return must be filed by the executor of the estate or by the or consider the new LLC form of organization. trustee of the trust. The current rate structure, with very low thresholds for the higher income tax brackets, discourages There are tax advantages and disadvantages associated with retaining income under ordinary circumstances. See 1RS both the investment and the business categories. Tax Publications 448, "Federal Estate and Gift Taxes," and 559, considerations, however—although important—are usually "Tax Information for Survivors, Executors, and Administra- not the primary factor that determines the best structure. This tors." decision should be made only after careful consultation with your legal, financial, and forestry advisors. Forms of timberland ownership and business organization are discussed in greater detail in Chapter XI.

16 Chapter V. Cost Considerations

Capital Costs Purchased Assets—\i a capital asset is purchased or funds are expended for its establishment as with reforestation, the For Federal income tax purposes, your expenditures as a original basis is its acquisition or establishment cost. This is forest owner may generally be classified as one of three the first entry to be placed in the capital account forthat types: (a) capital costs, which comprise basis; (These costs particular item. include those that are recoverable through allowances for depreciation and amortization, as well as those that are Inherited Assets—^The original basis of an inherited asset is recoverable only when the asset is sold or otherwise dis- its fair market value (or special use value if so elected) on the posed of) (b) currently deductible expenditures for manage- date the decedent died or on the alternate valuation date ment costs, taxes, and interest; and (c) costs of sale. The first provided by Federal estate tax law. The alternate valuation two types are discussed in this chapter; costs of sale are date, if elected, is the earlier of 6 months after the decedent's discussed in Chapter VI. death or the date an estate asset is sold. The value of most assets is usually greater than the decedent's basis. Passing Money spent to acquire real property or equipment, or to title by inheritance, therefore, generally results in a "stepped- make improvements that increase the value of real property up" basis for the property in the hands of the new owner. This or equipment already owned, is classified as a capital cost. can result in large income tax savings if it is sold. A Federal Examples of capital expenditures are those for purchase of estate tax return may not be required for many estates. In land, timber, buildings, and for machinery and equipment that case, the appraised value at the date of death for State having a useful life of more than 1 year. Other examples death tax purposes should be used as the original basis. include funds expended for construction of bridges, roads, Otherwise, use the fair market value of property at the date of and firebreaks; for site preparation, tree planting, and death. seeding; and for major repairs that prolong the life of machin- ery and equipment. All costs associated with the purchase, Assets Received by G/ft—In most instances, the original planting, or seeding of timber are capital expenditures. basis of an asset received by gift is based on the donor's Generally speaking, the property owner who incurs the adjusted basis. This is the case when the fair market value of capital costs is entitled to offset or deduct such costs against the gift on the date it is made is more than the donor's income arising from the property—and in some cases, adjusted basis—^which is the usual situation. For pre-1977 against income from other sources. gifts of this type, the new original basis is the donor's adjusted basis plus the entire amount of gift tax paid, if any, Capital costs usually cannot be deducted from income in their not to exceed the fair market value of the gift when made. For entirety in the year they are incurred. Instead they must be such gifts made after 1976, that portion of the gift tax, if any, used to establish or add to a capital account. This process of applicable is the difference between the donor's adjusted recording costs in an account so that they may be recovered basis and the gift's fair market value on the date made which over a period of years as the property is used up or worn out, is added to the donor's adjusted basis. If the fair market value or upon disposition of the property, is called "capitalization." of a gift when made is less than the donor's basis, then the At any given time the dollar value recorded in each account donee's original basis for loss purposes is the fair market represents the amount of unrecovered capital costs currently value. invested in properly for that account. The basic rules govern- ing which timber-related costs must be capitalized are Other Types of Acquisitior)—Other, less common ways of discussed in this chapter, as are recent changes in certain of acquiring property include non-taxable or partly taxable the methods of capital cost recovery. exchanges and replacement of involuntarily converted property (see page 46) such as that damaged or destroyed Original and Adjusted Basis by casualty or lost by theft. For a detailed discussion of these types of situations, see 1RS Publication 551, "Basis of Assets." When a capital asset is first acquired, the amount to be entered into the account for that particular asset depends on how the property was obtained, as discussed in the following Ailocatior) of Original Basis—Sa\es contracts and other paragraphs. This amount is the original basis of the acquired instruments transferring forest property often do not list property. The original basis may change as capital improve- separate prices or values for the land, timber, and other ments are made to the asset—or as allowances for depletion, assets when these are acquired in a single transaction. The amortization, or depreciation are deducted. Capital improve- total basis in such situations must then be allocated among ments will increase the basis; allowances for depletion, the various assets according to the separate fair market value amortization, and depreciation will decrease it. Procedures of each on the date the property was acquired. Example V-1 for making these changes are discussed in detail in illustrates and explains the allocation procedure. This Chapter XIV. The balance remaining in an account at any requirement applies no matter when the allocation is actually point in time after one or more changes have been made to made—even if it is done many years after the acquisition. If the original basis is called the adjusted basis. the timber represented a significant part of the total value of the property when it was acquired, but its quantity and value

17 Exampte V*l

E$tabn$bîng Jand and timber acooums: Yot^ bought a lOO-acro tract of ttmberland în 1991, The contract price wa$ $58.000, butyoü also paid $800 to have the boundaries surveyed, $350 for a titfe search and closing costs, and $t.200 to have the timber cruieed. Ttterefore. your total ac<|ui$îtîort co$t was $60,350. The timber cruise conducted at the time you made the purchase determined that the traca cor^taíned 1,000 cords of mercíhanteble pine pulpwood on 90 acre$. There were also lo acres oí young growth 4685, and multífáyíng by the total acquisition cost, 0,4685 x $60,350 gives an original cost basis of $2»,274 for the merchantdDle timbar. The original cost basis for each of the assets, detenmined in the same way, is shown m the following tabulation, and Is reported on Schedule B of Form T {Fi^ V-1 )>

Determination of Cost Basis

Proportion of Fair market total fair . Original Asset value market value cost basis

Land $ 27,500 0.4955 $ 29,903 Young growth 2J0ÛÙ 0.0360 2.173 Merchantable timber Sß.OPO 0,4Ç95, 29,274 Totat $ 55,600 1.0000 $ 60,350

as of that date are unknown, you will probably need a construction are treated the same as the expenses of forester's help to make these determinations. Only timber constructing temporary roads. Depreciation is discussed in with a fair market value as of the date of acquisition should greater detail later in this chapter. be included in the basis valuation. This means that if the allocation is being made after the acquisition date, the Timber Accounts—The timber account should include, if present timber volume must be reduced by the amount of applicable, separate subaccounts for merchantable timber, growth that has occurred since the timber was acquired. young growth (naturally seeded trees of premerchantable size), and plantations (planted or artificially seeded trees of Establishment of Accounts premerchantable size). Additional accounts can also be established using other criteria such as species and location. Land>4ccoani—Assets that are placed in the land account Each of these subaccounts should include two entries—one include the land itself and non-depreciable land improve- showing the quantity of timber and the other its dollar basis. ments. Nondepreciable land improvements include earthwork For merchantable timber, the quantity is shown in volume assets of a permanent character, either acquired with the measurement terms such as cords or thousand board feet property or constructed later. Examples are the roadbeds of (MBF). For premerchantable timber, the quantity is shown as permanent roads (those with an indeterminable useful life to number of acres. At the time timberland is acquired, a the landowner); land leveling; and earthen impoundments. reasonable amount of the basis should be allocated to young Their basis, like that of the land itself, generally can only be growth if it contributes to the overall value of the property. recovered when you sell or otherwise dispose of the land. The procedure outlined in Example V-1 should be used. It is Depreciable Land Improvement Account—Deprec\ab\e land important to remember that basis allocation must be made improvements include bridges, culverts, graveling, fences, with reference to the relative fair market values of the various fire towers, and other nonpermanent structures and improve- capital assets comprising the property at the time it is ments. Temporary roads, such as those to be abandoned acquired. If only cutting rights are acquired, all costs related after completion of a logging operation, may also be depreci- to the acquisition should be charged to the timber account. ated (or amortized). The costs of temporary firebreak

18 The quantity of merchantable timber to be entered in the Volume and value entries from the young growth and timber account as of the date of acquisition should be the plantation subaccounts should be transferred to the mer- volume that the tract would have produced if all of the chantable timber subaccount as soon as the trees in those merchantable timber had been cut and processed at that time two subaccounts become merchantable. The dollar amount in accordance with the prevailing utilization standards in the and the number of units are added directly to the merchant- locality. As explained above, the quantity of merchantable able timber account as shown in Example V-2. timber should be expressed in terms of thousand board feet, cords, or some other standard unit of timber measure. Example V-2

The plantation and young growth subaccounts reflect the AdjU8tmdnt of timber acóoünts: in 1994 you remeasure establishment of timber stands by planting, or by natural or the timber you bought tn ^xampte V-1> YOíí á^t^tmim íhat artificial seeding (see summary of Revenue Ruling 75-467, the young growth has reached merchantable size and page 91). As mentioned above, all timber establishment costs contains 80<:ord$. Tberafor^, you íran$íerth0 dollar are required to be capitalized. Establishment costs include amount $hown in the yot^ng ôrowth $übacöOünt and the funds spent to prepare a site for tree planting or seeding, for 0stimat0d number of units to the m^rchantabte tinker seedlings and tree seeds, and for labor and supervision. Site subaocotmt The closing 1994 {opening 1995) balance m preparation costs, in turn, are those incurred for brush, weed, the merchantable timber subaccount is, therefore, $30,447 and stump removal; and for leveling and conditioning the land {$28,274 plus $2.173). The balance in the young growth to afford good growing conditions and to facilitate planting or $ubacootini is reduced to $0^ The r0mea$urernent also seeding. They also include the costs of killing or removing cull indicated that the timbaron the 90 acre$ Qt^w k^ 200 or low-value trees to facilitate the natural regeneration of cords. Report the transfer on Schedule F of Form T desired species, and the baiting of rodents. {Fig.V^2).

Other related costs that must be capitalized include the allocable depreciation charges attributable to equipment used Equipment Accounts—Accounts also have to be established in site preparation, planting, and seeding—such as trucks, for depreciable equipment and machinery. This will usually tractors, and tree planters. The term "hired labor" includes consist of a subaccount for each item or class of items—such family members without an ownership interest in the property as power saws, tractors, trucks, and planting machines. The who are actually paid for their services, but it does not include basis of such items should be adjusted (increased) by any yourself. In certain cases, "hired labor" may also include your amounts spent for major repairs that significantly increase spouse. You, as a taxpayer, cannot capitalize the cost of your their value or prolong their life. The basis of machinery and own labor. Some expenditures made after seeding or planting equipment is recovered through depreciation allowances as are also establishment costs, such as those for brush and discussed later in this chapter. weed control, because a stand is not considered established until a number of individual stems sufficient to adequately Reforestation Tax Incentives stock the site with the desired species are capable of surviving. (See summary of Revenue Ruling 76-290, Qualified reforestation expenditures (or afforestation, in the page 92). case of planting or seeding non-forest land) paid or incurred in a tax year, to a maximum of $10,000, are eligible for a The costs of replanting or reseeding after seedling mortality, 10 percent investment tax credit (an offset against taxes such as death by drought, also have to be capitalized. owed) and for amortization (deduction) over eight tax years. Depending on the cause of death, however, you may be able The annual limit is $5,000 in the case of a married individual to claim the loss as an income tax deduction as explained filing a separate return. This favorable treatment was pro- later in Chapter VII. vided by Public Law 96-451, which was codified in Sections 194 and 48 of the Internal Revenue Code. It is an exception Capitalized reforestation costs in a tax year to a maximum of to the general rule that reforestation costs, which must be $10,000 may be recovered by being immediately amortized capitalized, are recoverable only when the timber is sold, cut, over a period of 84 months rather than by waiting to deduct or othenvise disposed of. Qualified reforestation costs are the them from sale proceeds when the timber is cut or otherwise direct expenses incurred in establishing a stand of timber— disposed of. The amortization procedure is described later in whether by planting, seeding, or natural regeneration as this chapter. Deductions against sale proceeds are discussed discussed above. in Chapter VI.

19 Form T (Timber) Forest Activities Schedules OMBNO. 1545-0007 (Rev. Aoni 1995) > Attach to your tax return. Oeoanmeot of the Treasury Attachment Intern«! Revenue Sennce For tax year ended , 19 Sequence No. o» Name

Paperwork Reduction Act Notice whether the acquisition is a purchase, exchange, gift, or We ask for the information on this form to carry out the Internal inheritance. Revenue laws of the United States. You are required to give us Schedule C—Complete for any year you sell or exchange the information. We need it to ensure that you are complying timber, timber cutting contracts, or forest land. with these laws and to allow us to figure and collect the hght amount of tax. Schedule D.—Complete if you claim a loss on your income tax retum for timber lost due to fire. wind, theft, or other causes. The time needed to complete and file this form will vary depending on individual circumstances. The estimated average Schedule E.—Complete only if you pay or incur expenses for time is: reforestation of forest land or for timber stand activities. Examples of reforestation expenses are oosts for site preparation Recordkeeping 37 hr.. 4 min. and for planting or seeding. Examples of timber stand activities Learning about the law or the form 35 mm. are precommercial thinning and fertilization. Preparing and sending the form to the 1RS . . 1 hr.. 14 min. Schedule F.—Complete for each timber account that has If you have comments conceming the accuracy of these time changed in quantity or dollar amount. A timber account may estimates or suggestions for making this form simpler, we woukj be change in quantity or dollar amount as a result of acquisitions, happy to hear from you. You can wnte to the 1RS. See the dispositions, the cutting of timber, capitalized expenditures, instructions for the tax retum with which this form is filed. casualty or theft losses, connections, additions for growth, and transfers from other accounts. Use Schedule F to figure General Instructions depletion for timber cut or the basis for timber sold or lost during Section references are to the Internal Revenue Code unless the tax year. Also use Schedule F if you treat the cutting of otherwise noted. timber as a sale or exchange under section 631(a). Who must file.—If you claim a deduction for depletion of timber Schedule G.—Complete to show changes m ownership of land or for depreciation of plant and other improvements related to during the tax year. timber accounts, or elect under section 631(a) to treat the cutting of timber as a sale or exchange, you must complete and Schedule H (optional).—Complete if you incur expenses for the attach Fomn T to your income tax retum. Generally, you should building of logging truck roads. If a timber company builds the file Form T when you sell or cut standing timber or are involved road but later charges the landowner for the cost, the landowner in other timber transactions. should complete Schedule H. Complete Fonm T in accordance with sections 611, 631, and Schedule I (optionaO.—Complete if you incur expenses for 1231 and related regulations. Complete only Schedules C and F building drainage structures, such as ditches. if you are a small-woodlot ovimer whose only timber-related For more information about Federal income tax rules and activity during the year was an isolated sale of timber. recordkeeping for forestry activities, see Agriculture Handbook Overview of form.—Form T has nine schedules. Use the No. 681. Forest Owners' Guide To Timber Investments. The following njles to determine which schedules to complete. Federal Income Tax, and Tax Recordkeeping. To order this Schedule A (optionaO-—If you do not send the Schedule A handbook, call 202-512-1800 (not a toll-free number) or wnte the maps in with Form T. you must make them available if your Superintendent of Documents, U.S. Government Printing Office, retum is examined. Washington, DC 20402. The handbook costs $7.00 (subject to Schedule B.—Complete for any year you acquire timber, change); its GPO stock number is 001-000-04540-7. timber cutting contracts, or forest land. Complete Schedule B Schedule A Maps (OptionaO This schedule consists of a map (or maps) of your timber enough detail to show cleariy the kx:ation of: (a) timber cutting properties. Whether you file the maps with your income tax retum contracts acquired separately from the land: (b) forest lands is your option, but you must make them available if your retum is acquired: (c) areas where you cut timber (d) timber sold or examined: Maps of convenient size are desirable, varying in scale otherwise disposed of under cutting contracts; (e) forest land from approximately 4 inches to the mile in small tracts to V^ inch sold or otherwise disposed of; and (f) forest land sold or to the mile in tracts larger than 200,000 acres. The maps should otherwise disposed of with the timber cutting nghts reserved to show your name and the tax year. Give standard map symbols in you or outstarujing in third parties. Schedule B Acquisitions Report acquisitions during the tax year (such as by purchase, pay-as-cut t)asis, except for those under which all cutting is exchange (whether taxable or not), gift, or inheritance) of completed within the tax year, do not complete lines 6 timber, timber cutting contracts, or forest land. Report through 10. Instead, briefly give the provisions of the separately each acquisition of $10,000 or more. You may purchase or lease agreement, including the number of years combine acquisitions of less than $10,000 for each account, from the effective date to the expiration date, annual and omit lines 4 and 5. For an acquisition by gift or minimum cut or payment, and the payment rates for different inheritance, do not complete line 6 through 8b. For an kinds of timber and forest products. Follow the format of lines acquisition or lease of timber-cutting rights on a 3 through 10 on additional sheets if necessary.

3 Name of block and title of account ' (Yr^ur Namp) Timhpr Arrr>imt Location of property (by legal subdivisions or map surveys) W^i of NEV of S. 5 & Wi^ of SE% of NE h of S 5, Spring Township, Pine County, Alabama You must include your timber in one or more accounts. Generally, each account must incluöe all your timber that is located in une -block." A biocK may be / Ji AH onLtional unit that includes all timber that would logically go to a single point of manufacture, (b) a logging unit that includes all timber that would logically he removed bv a single logging devetopmeot. or (c) an area established by the geographical or political boundanes of logical management area.^. Timber acquired ^dTa cunina contract may hot be included m part of a block, but shoukJ be kept in separate accounts. For exceptional cases, the timber .n a giveri block may oe :TJ"SZi more accounts. See Regulations section 1.611.3(d) for more information. Form T (Timber) (Rev. 4-95) Figure V-1. Schedule B of Form T (Timber). Cat No. 16717G

20 Form T n*hii|iiP>ÍWti à ijÇt ^ ?aae 2 Schedule B Acquisitions (Continued) 5a Name and address of seiler or oerson from wnom property was acquired b Date acquired

(To be completed) Oct. 2, 1991

6 Amount paid: a In cash I $58.000.00 b In interest-beanng notes c In non-interest-bearing notes 0 7a Amount of other consideration b Explain the nature of other consideration and how you determined the amount shown on line 7a: ^^^^^^^ ■^^M 8a Legal expenses $350.00 b Cruising, surveying, and other acquisition expenses $2.000.00

9 Total cost or other basis of property (add lines 6a through 8bl $60.350.00 10 Allocation of total cost or other basis on books: Costor oth«f Unit NumkMT of units Totti cost or othsr bssis •f unit a Forested land Acre JLûiL $299,03 $29.903.00 b Other unimproved land Acre c Improved land (deschbe) Acre

i.nnn $28.274.00 Merchantable timber (Estimate the quantity of r.nrds $28.274 merchantable timber present on the acquisition date. (See Regulations section 1.611-3(e).) Details of the timber estimate, made for purposes of the acquisition, should be available if your retum is examined.) Acres JiL $217-30 $ 2.173.00 Premerchantable timber. (Make an allocation here only if it is a factor in the total cost or value of the land.)

f Improvements (list separately)

g Mineral rights h Total cost or other basis (same as line 9). $60.350.00 Schedule C Profit or Loss From Land and Timber Sales 11 Generally, report alt dispositions during the tax year (such as lines 15. 19. and 20 only for amounts that must be reported by sale or exchange, whether taxable or tax-free) of timber, on your cun^ent year income tax retum. instead of filling in timber cutting contracts, or forest land. Do not report lines 16. 17. and 18. briefly state the provisions of the sale or dispositions by gift or distributions made by an estate to a lease agreement, including the number of years from the beneficiary. effective date to the expiration date, annual minimum cut or Report each sale involving total consideration of $10,000 or payment, and the payment rates for the different kinds of more. You may combine sales of less than $10.000 for each timber and forest products. You may combine small sales or timber or land account and omit lines 13 and 14 for each leases of timber-cutting rights on a pay-as-cut basis that combined small sale. For a sale or lease of timber-cutting were completed within the tax year. Follow the format of lines rights on a pay-as-cut basis, to be paid for at intervals during 12 through 20 on additional sheets if necessary. the cutting period according to the number of units cut, fill in 12 Name of block and title of account

13 Location of property (by legal suodivisions or map sun/eys)

Figure V-1. Schedule B continued. 21 Schedule E Reforestation and Timber Stand Activities 26 Summarize vour exoenses for reforestation and timber stand Planting or seeding.—Reooa the exoenses you incurred activities on this schedule. Keep detailed information to 3unng the tax year for planting seedlings or sowing seed to support the costs reported in this schedule and make it 'eforest the lana. Reoort seoarateiy for each deoletion available if your return is examined. Report on Scheoule E account. blocK. tract, or operating area tnbutary to a mill or expenses such as supplies, labor, overnead. transoonation. mill complex. Reoon contract worx separately from your tools, and depreciation on equipment. employees' worK. Site preparation.—Reooa all expenses mcun-eo dunna the Precommercial thinning or fertilization.—Report all tax year for prepanng the land for planting or seeding ' expenoitures that must be caoitalizea and items that you (including natural seeding). Include expenses for cleanng the elect to capitalize. Also, list on a seoarate attachment items land of brush and cull trees oy burning, disking, cnooping. that are currently deductible. Reoort separately for each sheanng and piling, spraying with herbicides, or other depletion account, block, tract, or ooerating area tnbutary to measures taken to aid successful site reforestation. Report a mill or mill comoiex. Repon contract work separately from separately for each depletion account, block, tract, or your employees work. operating area tnbutary to a mill or mill complex. Report contract work separately from your employees' work.

Kind of activity (burning, chopping, Account block, tract or armm Number of Total spraying, planting, saoding, thinning, acres treated expenditures paining, fertiiizing, etc.)

Total. Schedule F Capital Returnable Through Depletion On lines 27 through 42. give the data for each timber account purcnases with the opening balances and use the average separately. Cover any changes that have taken place dunng the depletion rate shown on line 34 for ail timber cut or sold, tax year. Attach as many additional pages of this schedule as regardless of how long held. If you exoress timber quantity in needed. If you deplete on the block basis, combine new MBF. iog scale, name the log rule useo ►

27 Name of block and title of account ► (a) (b) Quantity in MBF. tog scale: cords: Cost or or other unit other basis

28 Estimated quantity of timber and amount of capital retumable through deoletion at end of the immediately preceding tax year 29 increase or decrease of quantity of timber required by way of con-ection^.... 30a Addition for growth (penod covered ► years) b Transfers from premerchantable timber account c Transfers from deferred reforestation account 31 Timber acquired during year 32 Addition to capital during yeaH 33 Total at end of year, before depletion (add lines 28 through 32. in each column) 34 Unit rate retumable through depletion, or basis of sales or losses dine 33. column (b), divided by line 33. column (a)) 35 Quantity of timber cut during year 36 Depletion sustained (line 34 multiplied by line 35) 37 Quantity of standing timber sold or otherwise disposed of dunng year 38 Allowable as basis of sale (line 34 multiplied by line 37) 39 Quantity of standing timber lost by fire or other cause during year 40 Allowable basis of loss (line 34 multiplied by line 39) 41 Total reductions during year a Add line 35, column (a): line 37. column (a); and line 39, column (a) b Add line 36. column (b); line 38. column (b): and line 40, column (bl 42 Net quantity and value at end of year (line 33. column (a) less une 41 a. column (a); and line 33. column (b) less line 41b. column (b)) 'If MBF. log scale, is not me unit used, state wtiat unit you used and explain it. 'Adiust the quantity in MBF. log scale, or other unit remaining at the end of the year for changes in remventory. standards of use. scanered and/or mdefiniteiy ascertained losses, inaccuracy of the former estimate, or change m the log scaie it the log mie now m use ortters from me one useo as oasis for aeoietion m eamer years, if you maKe a Change, ciearty state the basis for it. ^Analyze the addition to show tne inoividuaJ items included. Include expenditures for taxes, administration, protection, interest actuaitv paid. etc.. if you did not treat these expenditures as expense deductions on your return. Cany expenditures for reforestation, sucn as site préparation, planting, seeomg. etc.. m a separate deferreo account.

43 Quantity of cut timber that was sold as logs or other rough products

Figure V-2. Schedule F of Form T (Timber) ^^ 'lUUPIIMèv ='3ge Schedule F Capital Returnable Through Depletion (Continuée) 44 Are you electing, or nave you made an election in a pnor tax 47 Descnoe in detail the cnaractenstics of the timber that affect year that is in effect, to report gam or loss from the cutting of its value, such as total quantity, species, quality, quantity per timber in accordance with section 631(a)? (This election is acre, size of the average tree, logging conaitions. distance to binding for all eligible timber cut in the election year ana all markets, and the like. subsequent years. You may revoke the election oniy with 1RS 48 Give evidence in the form of actual saies of comparaole timoer as consent, unless you made the election for a tax vear of the valuation date, along with other value evidence usea. beginning before 1987.) i;^ Yes H No Include a computation showing the aifference oetween the cost If "Yes. " furnish the information asked for in items 45 through (excluding timber or stumpage cost) and value of the pnmary wood product (logs or other roundwood. chips, etc.) at the miil or plant. Give detailed evidence that permits a companson with the 45 Gain or loss on standing timber as reported on Form 4797. timt^er on which you report a value. Sales of Business Property. Show the adjusted basis for depletion and the fair market value, by species and unit rates 49 For all purchases and sales of timber you make, and for all if reported on a species basis. Section 631(a) requires you to other transactions you report, fumish the relevant information determine the fair market value of timber cut during the year from lines 2 through 20. for timber you owned, or held under contract right to cut, for 50 Fumish the following additional information: more than 1 year. The fair market value is the value of the a« Location of the sawmill, log market, or other point of timber as it stood in the forest on the first day of the tax year. delivery of the logs or wood to the user or buyer. 46 Fumish the date of acquisition of timber that was cut in the tax b. The total MBF. log scale, cords, or other units of timber year, if acquired after March 1. 1913; the quantity of timber cut, and the length and diameter of the average log or the remaining (adjusted for growth, conwnion of estimates, changes average number of units per tree. in use. and any change in the log mie used); and the adjusted basis at the t)eginning of the tax year. State the acreage cut over c. The percentage of rough lumber grades, by species, and the amount of timt^er cut from it during the tax year and the manufactured from the timber during the yean or. if cut log rule or other method you used to determine the quantity of timber is sold as logs, the percentage of log grades, oy species. timber cut. If you kept depletion accounts by separate tracts or purchases, give the information separately for each tract or 51 Section 631(a) applies only to timber owned, or held under a timtser purchase. contract right to cut, for a period of more than 1 year. In your records show the quantity of timber cut that you held for If you used an average depletion rate based on the average more than 1 year. Show separately the quantity of timber cut value or cost of a timber block in eariier years, the adjusted that was held for less than 1 year. Also, the scale of logs basis referred to in section 631(a) is the average basis shown purchased during the year must be shown by species and on lines 34, after adjustment. quantity and excluded from the quantity shown as cut under section 631(a). Records must also show the number, cost, and point of delivery of purchased logs by species and grade. Schedule G Land Ownership 52 Show changes in land accounts as carried on your books. Attach as many additional sheets as you need, following the format of lines 53 through 58. Total cost 53 Name of block and title of account ► or other basis. Ghre Acres amount of March 1. Avecaçe rate 1913, appreoation, if included 54 Balance at beginning of year 55 Acquisitions during year 56 Sales during year 57 Other changes 58 Balance at end of year (add lines 54 and 55. less lines 56 and 57) Optional Schedules

59 If the supporting statements for Schedules H and I are too numerous to file with your return, keep this infonmation and make it available if your retum is examined. Include separate cost accounts for construction by you and by the contractor. Schedule H Road Construction Cost 60 Report on lines 61 and 62 the expenditures incun-ed for road construction during the tax year. Use a separate schedule for each depletion account, block, tract, or geographic area tnbutary to a mill or mill complex. 61 Roads constructed on lands owned in fee: a Miles constructed ► b Amount capitalized to nondepreciable account c Amount placed in depreciation account. . . d Amount claimed as an ordinary expense . . e Total amount spent (add lines 61b through 61d) 62 Roads constmcted for logging timber held under leases or cutting contracts having a term of 2 years or longer a Miles constructed ► b Amount to be amortized c Amount claimed as an ordinary expense d Total amount spent (add lines 62b and 62c)

Figure V-2 Continued 23 As an alternative, for those engaged in the business of Anfiortízatíon farming, some or all of Conservation Reserve Program (CRP) expenses for tree planting may be deducted annually under Amortization ot reforestatton expenditures must be specifi- Code Section 175. This section provides that certain soil and cally elected in writing. It is extremely important that this is water conservation expenditures may be deducted that would done on a timely filed return, including extensions, for the tax othen^^ise have to be capitalized. In order to qualify, the year in which the expenditures are made. The election cannot expenditures must be consistent with a plan approved by the be made on an amended return. Once the election is made, USDA Natural Resources Conservation Service office for the however, missed amortization deductions can be taken on area where the land is located, or by a comparable State amended returns. To make this election, you should attach agency. The limit on the amount that can be deducted in any Form 4562 to your income tax return and enter the required one year is 25 percent of the taxpayer's gross income from information and the deduction in Part VI, which concerns farming during that year. amortization. Also attach to the form, on a plain sheet of paper, a statement giving the amount of the expenditure, the Expenditures for timber stand improvement (TSI) practices in nature of the expenditure, the date incurred, the type of established stands do not qualify for the amortization and tax timber being grown, and the purpose for which the timber is credit. However, they generally are for maintenance of the being grown. A separate statement must be included for each stand and, thus, are eligible for deduction as a current property for which reforestation expenditures are being expense, subject to the passive activity loss rules, as amortized. discussed later in this chapter. Alternatively, they may be capitalized and deducted when the timber is cut, sold, or The amortizable basis of reforestation investments must be othen/vise disposed of. reduced by 50 percent of the investment tax credit taken. Thus, if the 10 percent tax credit is taken (discussed in a later paragraph), only 95 percent of the eligible reforestation Individuals, estates, partnerships, and corporations are expenditure (a maximum of $9,500 per year) may be amor- eligible for either or both the amortization and credit. Trusts tized. The amount attributable to the 5 percent reduction is are not eligible for either one. The $10,000 annual limit permanently lost—it may not be capitalized to be recovered applies to both the partnership and to each partner, and, in later when the trees are cut or sold. A half-year convention the case of an S corporation (see Chapter XI), to both the applies to amortization deductions. This means that only corporation and each shareholder. Thus, a partner's or 1/14th of the eligible cost can be deducted the first year. One- shareholder's total annual reforestation expenditure from all seventh is deducted in each of years 2 through 7, and the sources eligible for the amortization and credit cannot exceed remaining 1/14th in the eighth tax year. There is no carryover $10,000. to subsequent years of expenditures in excess of $10,000 per year. These amounts remain in the reforestation or young To qualify for the reforestation amortization and credit, the growth capital accounts for later transfer to a merchantable reforested or afforested property must be at least one acre in timber account. Eventually they may be recovered when the size and be located in the United States. The site must be trees are sold or otherwise disposed of. held by the taxpayer for planting, cultivating, caring for, and cutting of trees for sale or for use in producing commercial The form on which to report the deduction depends on the * timber products. Both owned and leased property qualify. status of the taxpayer. Forthose who report as investors rather than as a business, the deduction is shown on the line Christmas tree establishment expenditures do not qualify for for adjustments to income on the bottom of the front page of either the credit or the amortization. The costs of planting Form 1040 by writing "reforestation" and the amount of the trees in shelterbelts and windbreaks, and of trees planted deduction on that line. This amount is included in total primarily for nut production and as ornamentals, also do not adjustments to income. It is not necessary to list the amorti- qualify. zation deduction as an itemized deduction on Schedule A. For those taxpayers whose timber holdings are treated as a Reforestation expenditures eligible for the amortization and business (see Chapters IV and XI), the amortization deduc- credit do not include those reimbursed under a public cost- tion is taken on the "other expenses" line of page 1 of share program unless the reimbursed amount is included in Schedule C and explained on page 2. For farmers, it is taken taxable income by the recipient. If the cost-share payment is on the "other expenses" line of Schedule F If reforestation recorded as income, the total reforestation cost (including the expenditures are incurred in more than one year, a separate cost-share payment), subject to the $10,000 annual limitation, schedule must be maintained for each year and reported on qualifies for both the amortization and the tax credit. Refores- Form 4562 according to the instructions. tation costs incurred under the CRP program, including the cost-share payments received, are eligible for the amortiza- If the trees are disposed of within 10 years, all of the taxes tion and credit if not deducted as discussed above. CRP cost- saved by amortization deductions claimed are subject to share payments are always reportable as income; they are recapture as ordinary income (to the extent of any gain never eligible for exclusion. The tax treatment of cost-share realized from the disposal). There is no recapture, however, if payments is discussed on page 40. the property is disposed of by gift, and generally recapture ' may not occur with respect to transfer at death, like-kind exchange, involuntary conversion, and certain tax-free transfers such as a transfer to a corporation you control.

24 The Credit personal property associated with or used in your timber operation if the operation qualifies as an active trade or The investment tax credit is reported in Part I of 1RS business. This option is called the Section 179 deduction. You Form 3468. Any unused credit may be carried back to tax must elect to take the deduction on the first income tax return returns for the three preceding years and then forward for for the tax year in which the property is placed in service 15 years until used. If the trees are disposed of before (whether or not the return is timely) or on an amended return 5 years, part or all of the credit is subject to recapture on filed within the time prescribed by law (including extensions) Form 4255. The only exception is for transfers at death. The for filing the return for such tax year. Otherwise, the Section recapture percentage is 100 percent during the first full year 179 election cannot be made on an amended return. An after seeding or planting; it then decreases by 20 percentage estate or trust cannot make the Sect- ion 179 election. points every succeeding full year. No credit is recaptured If you elect the deduction, you must specify the part of the after the fifth full year. For additional information, see the cost of each item you elect to deduct. The amount of the instructions for Form 4255, "Recapture of Investment Credit." Section 179 deduction is subtracted from the basis of the property concerned before computing depreciation. You Example V-3 shows how to claim the reforestation amortiza- report the Section 179 deduction on Form 4562. tion and credit. The $17,500 deduction is reduced one dollar for each dollar Ipxample V-3 of investment over $200,000 during the tax year in question in Section 179 property. Thus, if you place $208,000 of Reforestation amortization and credit: Assume you qualified property in service in a particular tax year, only refor$sted 120 acres during the tax year at a cost of $100 $9,500 ($17,500 - $8,000) qualifies for the deduction. The per acre, resuiting in a total cost of $12,000. You receive no deduction is also limited to the amount of aggregate taxable cost'Share payments. income (computed without subtracting the Section 179 deduction) attributable to your active conduct of trades or Wien you file your income tax return for that tax year, you businesses. Depreciable investment property or property held can take the tax credit on $10.000 of the reforestation for personal use does not qualify. The amount of eligible cost expense and amortize $9,500 of it—the maximum amount of that is not deductible in one tax year because of insufficient expenditure that qualifies in anyone year. The remaining active trade or business income may be carried fonA^ard $2.000 must be capitalized to the plantation subaccount indefinitely to later years until it can be deducted (see The amortization would be eîected as explained earlier. Example V-4). The amount amortized is $9,500—the $10^000 allowable reforestation expense tess half of the $i»000 tax credit. Example V-4 Under this option, $679 {1/14ih of the $9,S00 allowable cost) is amortized in the first year. During each of the next Section 179 deduction: Assume you invest $7.000 in a 6 years^ $1,357 or 1/7th of the cost would be deducted, . tised truck and $20,000 în a used tractor, both for your and the remaining $679 would be deducted in the eighth timber business. You have $9,000 of aggregate taxable year. The investment tax credit of $1,000 is claimed on active business Income for the tax year In question. You Form $466. may elect on Fonm 4562 to expense under Section 179for the $7,000 cost of the truck, and $10.500 of the cost of the The Section 179 Deduction and Depreciation tractor for a total of $17,500 (or you could elect all $17,500 on the tractor). Your total deduction for the tax year is Timber producers often have large investments in machinery Bmited to the $9.000 of aggregate active trade or business and equipment, and in land improvements such as bridges, income. The $8,500 difference between the $9,000 taxable fences, and buildings. The internal Revenue Code allows you income limit and the $17,500 maximum dollar Itmît may be to take annual depreciation deductions on such property that carried forward to future tax years until used up. is either used in a business or held for the production of income (as an investment); has a determinable useful life; The net benefit from the Section 179 deduction must be and wears out, decays, gets used up, becomes obsolete, or recaptured if the property in question Is not used tn ^n . loses value from natural causes. This section briefly explains active trade or business more than 50 percent of the t&ne major changes made by the 1986 Tax Reform Act, and other in any tax year before the property*s recovery (depreda- changes in the Federal income tax law since 1987, in the way tion) period expires. Recapture of the Section 179 deduc- depreciation is calculated. The basic rules are summarized to tion is reported on Form 4797. give an overview to timber owners and operators for tax planning purposes. The fine points and exceptions to the Depreciation rules are omitted because of space limitations. You should consult 1RS publication No. 534 or your accountant for You, as a forest owner, may depreciate most property used additional information on specific problems. on your woodland if you hold your woodland as either a business or as an investment. Property acquired either new Section 179 Deduction or used may be depreciated. Land is never depreciable, but certain improvements to land such as fences, temporary You may be able to deduct immediately as an expense up to roads, bridges, and buildings are depreciable. To claim $17.500 per year of the cost of qualifying depreciable depreciation, you use the Modified Accelerated Cost

25 Recovery System (MACRS) established by the 1986 Tax Section 168 of the Internal Revenue Code prescribes the Reform Act for most tangible property placed in service after applicable conventions (half-year, mid-quarter, and rnid- 1986. You cannot change to MACRS for property placed in month) to be used in computing depreciation deductions for service prior to 1987 that is being depreciated under another the tax year in which MACRS property is placed in service method such as the Accelerated Cost Recovery System and the tax year in which the property is disposed of or (ACRS). Under MACRS, property is assigned a class life that retired from service. Under the half-year convention, property determines the depreciation recovery period. The recovery (other than residential rental property and nonresidential real periods for property under the General Depreciation System property) placed in service, disposed of. or retired at any time of Section 168 of the Internal Revenue Code are 3, 5, 7, 10, during the tax year is treated as being placed in service, 15, and 20 years. For residential real property, the period is disposed of. or retired on the mid-point of such year. Under 27.5 years, and for nonresidential real property, the recovery this convention, a half-year of depreciation is allowable for period is 39 years. If the property was placed in service the first year eligible property is placed in service regardless before May 13,1993, the recovery period is 31.5 years. Table of when the property is actually placed in service during that V-1 shows the recovery periods for certain types of property year. If the aggregate basis of this depreciable property typically associated with woodland operations. placed in service in the last 3 months of the tax year exceeds 40 percent of the aggregate bases of all such property placed Under MACRS, 3-, 5-, 7-, and 10-year properties are depreci- in service during the tax year, the applicable convention for ated in the beginning years using the 200 percent declining this property is the mid-quarter convention. Under the mid- balance method, and 15- and 20-year properties are depreci- quarter convention, all property placed in service, or disposed ated in the beginning years using the 150 percent declining of, during any quarter of a tax year, generally is treated as balance method. Depreciation is determined by the straight being placed in service or disposed of on the mid-point of the line method starting in the tax year when it maximizes the quarter. The allowable depreciation is a percentage of the depreciation allowance. Under MACRS, you may also, in depreciation for a full year; for property placed in service in certain circumstances, calculate depreciation using the the first quarter of the tax year, 87.5 percent; in the second straight line method. You may elect to exclude certain timber- quarter, 62.5 percent; in the third quarter, 37.5 percent; and in related property, such as temporary logging roads, from the fourth quarter, 12.5 percent. MACRS and depreciate it under the unit-of-production method or any method of depreciation not expressed in a The applicable convention for residential rental property and term of years. With this method, a timber owner depreciates nonresidential real property is the mid-month convention. the property based on the number of units of timber har- Under the mid-month convention, property placed in service, vested in a tax year as compared to the total number of units or disposed of, during any month of a tax year, is treated as to be harvested over the life of the property. An example is a being placed in service, or disposed of, on the mid-point of logging road constructed solely for use in harvesting specified that month. Thus, regardless of when during the month a timber and which on completion of harvesting will no longer taxpayer places residential rental property or nonresidential be useful to the timber owner.

Table V-1—Recovery Periods by Type of Property Under the General Depreciation System of Section 168 of the Internal Revenue Code

MACRS ^ Recovery Period Type of Property (Years) 3 Over-the-road (semi-) tractors 5 Automobiles and pickup trucks; logging machinery and equipment and road-building equipment used by logging and sawmill operators and pulp manufacturers for their own account. Farm machinery and equipment such as tractors and planting machines, and farm fences. Before 1989, single purpose agricultural or horticultural structures; after 1988, these single purpose structures are 10-year property. Also, any property that does not have a class life and is not otherwise classified under Sections 168(e)(2) or (3). 10 Property with a class life of 16 years or more, but less than 20 years. 15 Land improvements such as bridges, culverts, and nonfarm fences. 20 Farm buildings (except single purpose agricultural or horticultural structures). 27.5 Residential rental property. 31.5 Nonresidential real property placed in service before May 13,1993. 39 Nonresidential real property placed in service after May 12,1993. Modified Accelerated Cost Recovery System

26 Example V^9 Alimberland owner spent $20,000 for a multi-purpose machine shed which he placed in service In July 1994. He additionally purchased end placed in service in his bü$ln$$s a $BO,000 gsedover^he-foad tractor In September md a $30*000 g$0d fuller- tired skidder in October. No other depreciable property was placed in service by him in 19Ô4. He also spent $12,000 tn December to plant seedlings on 100 acres of hlstlmberland He Is on a calendar-year tax basis. Since not more than 40 percent of the value of personal property purchased during the year (tractor andsktdder) was placed in service in ^e lest quarter of the tax year of tH$ cal^ndar^year taxpayer^ the half-year convention applies a$ foitowe; Section 179 deduction (he elects to dedudt part of ^0 sksdder'e coet) $ 17,500 MACRS deduction or^tiie over-tiie-road iractor (3-^year property) $6ÛpÛÛ0yd years x ¿00% x 1/â year $20,000 MACRS dedtrtítíon on m skidder (5*year property} ($30,000 ^$17*SÛ0 Sec. 17Ô)/S years x 200% x t/2 year $ 2,500 »4A0fi$ deduction

real property in service, the property is deemed to be placed deducted (expensed) each year as incurred, even if the in service on the mid-point of the month. property is currently producing no income—provided that the timber growing activity is being engaged in for profit and the This example illustrates the importance of planning pur- expenditures are directly related to the income potential of chases. By purchasing and placing the tractor in service in the property. A presumption that an activity is being carried on September before the last quarter, $40,235 of the cost of the for profit applies if there has been net income from the equipment was deductible in 1994 compared to $23,360 property (profit) in at least three of the five consecutive years (=17,500+5,625+235) if all of the personal property were ending with the current year. If this test cannot be met, purchased and placed in sen/ice in the last quarter of the tax however, deductions are not automatically denied. Rather, all year. facts and circumstances of the situation are considered in determining whether or not a profit motive exists. The term Operating Expenses and Carrying Charges "profit" includes appreciation in the value of assets. This principle is particularly relevant in the case of timber, which is Timber owners commonly incur costs associated with the unique property in that its appreciation in value—contrary to day-to-day management of their forest property. Such most other assets—is due primarily to physical growth and expenditures include, but are not limited to, fees paid to enhanced quality over a long period of time. Although there is consulting foresters; travel expenses directly related to the often no net income from forest properties for many years, income potential of the property; the costs of silvicultural the intent of most owners is to achieve an overall profit once activities such as prescribed burning and precommercial the increase in timber value is realized. thinning; the expenses of fire, insect, and disease control and protection; the costs of tools having a short, useful life; As an alternative to currently deducting timber-related expendi- salaries for hired labor; road and fire break maintenance tures, you may elect to capitalize them if you so choose. Strictly costs; and professional fees. These types of expenditures are speaking, only carrying charges may be capitalized. Carrying commonly called timber operating costs. Woodland owners charges are taxes, interest, and certain other expenses related also generally incur expenses for property taxes and perhaps to the development and operation of timber properties that may for interest and insurance. Such costs, together with certain be treated as either deductible expenses or capital costs. As a other expenses related to the development and operation of practical matter, however, many other deductible timber-related timber properties, are termed "carrying charges." costs are considered to be carrying charges. Capitalized carrying charges are added to the timber's basis and are Operating costs and carrying charges that are considered to recovered by offsetting gain realized upon the sale or cutting of be "ordinary and necessary" expenses of managing, main- timber, as discussed on page 31. taining, and conserving forestland may be wholly or partially

27 Although the regulations governing the capitalization of If your timber ownership is subject to the passive loss rules, carrying charges do not specifically address timber-related you must determine which of the following three classifica- costs, they do set forth general rules that are applicable to tions applies to you and your forest property. This determina- the capitalization of timber expenditures. They provide that in tion must be made for each tax year. The rules for deducting the case of "unimproved and unproductive real property," operating costs and carrying charges vary, depending on taxpayers may elect—on a year-to-year basis—to capitalize which of these categories your timber activity fits. The three "annual taxes, mortgage interest, and other carrying categories are as follows: charges." Unimproved real property is generally defined as (1) timber held as part of a trade or business in which you land without buildings, structures, or any other improvements materially participate; that contribute significantly to its value. Forest land is (2) timber held as part of a trade or business in which you do unproductive in any year in which no income is produced not materially participate (that is, a passive activity); and from its use—such as from hunting leases, timber sales, or (3) timber held for the production of income (that is. as an sale of products cut from timber. You may not capitalize investment), but which is not part of a trade or business. carrying charges incurred in any year your property is productive. Timber Held as Part of a Trade or Business in Which the Taxpayer Materially Participates The regulations additionally provide with respect to real property "whether improved or unimproved, and whether In this situation, all operating expenses and carrying charges productive or unproductive," that taxpayers may elect to related to the timber activity are fully deductible against capitalize necessary expenditures associated with develop- income from any source each year as incurred. Credits ment of the property up to the time the development is arising from the timber activity (such as the reforestation tax completed. Once made, however the election to capitalize credit discussed on page 25) can also be applied to taxes "development-related expenditures" continues in effect until associated with income from any source. If your total deduc- development has been completed. Costs incurred for tions from your trade or business activities (including your silvicultural treatments in established stands—such as forest property) exceed your gross income from all sources ' precommercial thinning and other timber stand improvement for the tax year, the excess will be a "net operating loss." (maintenance) work—fall into this category. This means that This loss generally may be carried back to the 3 preceding such costs may be capitalized to the timber account if you do tax years, and if still unused, then be carried forward to the it consistently from year to year. next succeeding 15 tax years.

You elect to capitalize by filing with your original tax return for Material Participation—The law provides that to be "materially the year for which the election is to be effective a written participating," a taxpayer must be involved in operations with statement on a plain piece of paper indicating the cost items respect to the property on a basis that is "regular, continuous, you are capitalizing. The election cannot be made on an and substantial." Both you and your spouse will be treated as amended return. one taxpayer for purposes of determining whether the material participation requirement has been met. It does not The Passive Loss Rules matter whether your spouse owns an interest in the property or not, or whether you file joint or separate tax returns. The extent to which operating costs and carrying charges are According to temporary regulations issued by the Internal currently deductible depends on how you are classified under Revenue Service, you will be considered to be materially the 1986 Tax Reform Act with respect to ownership and participating in the operation of your timber activity if you operation of your forest property. This legislation made a meet at least one of the following tests: number of significant changes related to deductions that are (1 ) You and your spouse participate in the activity for more set forth in what are called the "passive loss rules." than 500 hours during the tax year. (2) You and your spouse's personal participation in the The passive loss rules govern the extent to which an operat- activity constitutes substantially all of the participation ing loss from a particular activity for any given tax year can (including that of all other individuals) for the tax year. be offset against income from other sources. The passive (3) You and your spouse participate in the activity for more loss rules apply to individuals, estates, trusts, and to two than 100 hours during the tax year and no other individual categories of corporations: "personal service corporations" participates more. (those whose principal activity is the performance of personal (4) You and your spouse's aggregate participation in all of services that are substantially performed by employee- your "significant participation activities," including your owners) and "closely held C corporations" (those that are timber activity, exceeds 500 hours during the tax year. An subject to the corporate income tax and in which more than activity is a "significant participation activity" if it is a trade 50 percent of the value of the stock is owned by five or fewer or business in which you participate for more than individuals). Except for these two types of corporations, the 100 hours during the tax year. Thus, you could qualify passive loss rules do not apply to corporations generally. The under this test even if another individual who co-owns passive loss rules also do not apply directly to partnerships forest property with you participates in its operation more and Subchapter S corporations since they are essentially than you do during the tax year in question. "flow-through" entities that are not taxed in their own right. (5) You and your spouse materially participated in the activity However, the rules do apply to deductions passed through for any of 5 of the preceding 10 tax years. For this from partnerships and Subchapter S corporations. purpose, material participation in pre-1987 tax years is

28 counted. However, you must meet the 500-hour test to corporations can currently deduct operating costs and qualify in any of those years. carrying charges associated with passive timber ownership (6) If all the facts and circumstances of the situation indicated from income from any source without limitation. Generally, that you and your spouse participated in the activity on a deductk)ns attributable to passively held forest properties and regular, continuous, and substantial basis during the tax other passive activities by taxpayers subject to the passive year. The specific rules to be followed in applying this test loss rules are allowed only to the extent of the taxpayer's have not been issued by the Internal Revenue Service at income from all passive activities during the tax year. An this writing. However, several general principles may exception to this rule is that closely held C corporations (other currently be used as guides. The first is that your man- than personal service corporations) are permitted to offset agement of the timber activity isn't taken into account if a deductions from passive activities against income from active paid manager participates in its management or if your businesses (but not against portfolio income, which includes management services are exceeded by those performed such items as dividends and interest). Credits attributable to by any other individual. And second, if you don't partici- passive timber ownership (such as the reforestation tax credit pate in the timber activity for more than 100 hours discussed on page 25) may only be applied to offset taxes during the tax year, you cannot satisfy the facts and associated with income from passive activities. circumstances test for the year. Generally, casualty loss deductions are not subject to the Formal recordkeeping is not required to prove the number of passive loss rules. Such deductions (see Chapter VII) may be hours you devote to operation of your timber activity. You are taken currently against income from any source by passive allowed to document the number of hours by any reasonable taxpayers as well as by those who are material participants. means, including—but not limited to—^appointment books, calendars, and narrative summaries. If your deductions from a passive timber ownership (including depreciation and amortization deductions) exceed your Sun^iving Spouses—In some cases, surviving spouses of passive income (from all sources) for the tax year, the excess retired or disabled persons may not be subject to the material may be carried fonvard and used in future years when you participation tests. If the timber ownership qualifies as a farm either realize passive income or else dispose of the entire business under Section 2032A of the Internal Revenue Code timber ownership that gave rise to the passive loss. Credits (relating to estate tax special use valuation of farm and not used during a particular tax year may also be carried forestland), such persons need only satisfy an "active forward (but not back) for use in future years, but may not be management" test. This test involves no specified number of taken solely because you dispose of your entire ownership hours nor does it impose restrictions on participation by other interest. In certain cases, you may elect to increase the basis persons. Rather, the taxpayer need only be involved in of property by the disallowed credit immediately before the making major management decisions and not day-to-day transfer of the property. operating decisions. For tax reporting, computation of allowable passive deduc- Reporting Expenses—If your timber operations are incidental tions for the tax year is calculated on Form 8582, "Passive to farming activities, list your deductible timber expenses Activity Loss Limitations." It is beyond the scope of this together with your deductible farming expenses on Sched- publication to describe in detail the use of this complex form. ule F of Form 1040, "Farm Income and Expenses." There are If your timber ownership is passive in nature, you may want separate lines for tax and interest deductions. Timber to consult a professional tax advisor concerning the use of operating costs and carrying charges for which there are no Form 8582. specific line entries should be itemized on the line for "other expenses." All such deductions should be individually listed. Timber Held as an Investment

If your timber operations are a separate business, or are The third category is timber held as an investment, rather incidental to a nonfarm business, report your timber deduc- than as part of a trade or business. The distinction between a tions on Schedule C of Form 1040, "Profit or (Loss) from 'Irade or business" and an "investment" is not always an easy Business or Profession." There are also separate lines on one to make. All the facts and circumstances relating to the Schedule C for tax, interest, and certain other specific activity have to be examined. In general, however, an deductions. Other timber-related deductions should be investment is an undertaking entered into or engaged in with individually listed on the line for "other expenses." a view to realizing a profit—but which does not involve the same regularity or frequency of activity that a trade or Timber Held as Part of a Trade or Business in Which You business would require. Corporations in the investment Do Not Materially Participate category can fully deduct operating costs and carrying charges against income from any source. However, as The second category is timber held as part of a 'Irade or described next, the deductibility of these expenditures by business" in which you do not materially participate in one of noncorporate investors is generally more limited. the ways discussed above. Under the passive loss rules, this type of forest ownership is classified as a "passive activity." Management Cösfs—Both corporate and noncorporate C corporations (those subject to the corporate income tax) timber owners may generally deduct management costs that are not classified as closely held or as personal service relating to timber held as an investment against income f;om

29 any source. Management costs, as used here, include all for the tax year. Net investment income is your investment operating costs and carrying charges except property taxes income less expenses other than interest expense that are and other deductible taxes, and interest. However, for directly connected with production of the investment income. noncorporate taxpayers, such expenditures are classified as (See 1RS Publication 550. "Investment Income and Ex- "miscellaneous itemized deductions." This means that they penses.") Beginning in 1993, investment income generally can be deducted only to the extent that, when aggregated cannot include capital gains realized from selling investment with all of your other "miscellaneous itemized deductions," the property. Example V-6 explains how much investment interest total exceeds 2 percent of your adjusted gross income. The expense can be deducted. proportion of such deductions that falls below the 2-percent floor is permanently lost. Other types of "miscellaneous Example V-6 itemized deductions" that you may incur include, but are not limited to, costs of tax return preparation, safe-deposit box Deductbn of investment interest expenses: Suppose you rental, financial journal subscriptions, and investment advice. Incur $3,000 of investment interest expenso in í 994 bat Timber management costs in this category may also be only have $2.000 of net investment income. You may not capitalized as carrying charges as discussed on page 27, if deducá the full $3,000 of interest paid. Rattier, you may you prefer. However, the same expenditure cannot be deduct only $2,000 (amount of net investment încon^e). counted toward the 2-percent floor on "miscellaneous Any excess of investment interest expense over net itemized deductions" and also be capitalized. investment income that cannot be deducted in a partícülar tax year (such ^s the $1,000 in this example) may be Taxes—Property and other deductible taxes attributable to carried forward Indefinitely and b^ efigtble for deduction In your timber held as an investment are deductible in full each any later year in which net învestment income—from any year against income from any source by both corporate and investment $ource~i$ realfeed. noncorporate taxpayers. Tax deductions by noncorporate timber investors are not "miscellaneous itemized deductions" As discussed above, you may elect to capitalize all or part of and therefore are not subject to the 2-percent floor for such the interest paid, instead of deducting it or carrying it fonward, deductions. If you prefer, you may elect to capitalize property and thus use it to offset income realized from sale of the taxes and recover them upon sale of the timber rather than timber. deduct them in the year paid. Severance and yield taxes may not be capitalized; however, they may be currently deducted. Reporting Expenses—Your deductible investment expenses are listed on Schedule A of Form 1040 on the appropriate line /nieras^—Corporate taxpayers may deduct unlimited timber for each type of deduction. This is possible only if you itemize investment interest expense against income from any source. deductions for the year. If in any tax year you do not itemize If you are a noncorporate timber investor, however, you may deductions, or alternatively do not elect to capitalize these deduct interest expense (from both timber and nontimber expenses, the costs are lost for tax purposes, and you will not sources) only up to net investment income (from all sources) be able to recover them.

30 Chapter VI. Income Considerations

Timber Sale Receipts timber sale, the growth determination can easily be made by reestimating the total volume of merchantable timber present When you dispose of standing timlDer, you must determine on the tract at the same time that the trees to be cut are the type as well as the amount of gain or loss for Federal marked or otherwise selected. Adjusting a timber account is income tax purposes. The type of gain or loss will depend discussed and illustrated in detail in Chapter V. upon how long you have owned the timber, your purpose for owning it, how you dispose of it, and what kind of timber- How to Recover Your Basis—Once the adjusted basis has related activities you normally engage in. been calculated, it is necessary to determine the depletion unit. This is done by dividing the adjusted basis shown in the Determining the Amount of Gain or Loss timber account by the total volume of timber in the account. The depletion unit is usually expressed in dollars per unit of Net gain or loss from the disposition of timber is generally measure, such as thousand board feet, cubic feet, tons, determined in the same way as for most other assets. The cords, etc. However, the unit for Christmas tree operations total amount received is reduced by any expenses directly may be the individual tree. A depletion unit should be related to the transaction and by the adjusted basis of the determined for each timber account. Although the depletion timber. A special rule applies to certain timber cut by the unit is always determined in the same way, how you use it to owner, as explained later on page 36. When timber acquired recover your basis in timber depends on whether you as a single unit is disposed of in more than one transaction disposed of standing timber or, alternatively, cut it yourself. over a period of years as the trees mature, special proce- dures must be used to determine the deductible basis of the Recovery of Basis—Disposal of Standirig Timber—Standing timber disposed of at any one time. The procedures and rules timber may be disposed of by either a lump-sum sale or for doing this have not changed since the last edition of this under a pay-as-cut contract. Both are discussed in detail later publication. in this chapter. With either method, basis is recovered by reducing any proceeds received by the adjusted basis of the Costs of Sale—Timber selling expenses are those costs timber disposed of. Example VI-1 illustrates use of the incurred by you that are directly related to the sale or disposal depletion unit to recover basis, and the determination of net of timber. They include, but are not limited to, the costs of gain from the disposal of standing timber. advertising, timber cruising, travel, marking and scaling; as well as fees paid to consulting foresters, appraisers, and E)¿anlpio Vi-1 selling agents. Such expenditures cannot be deducted from ordinary income not resulting from the sale, but instead Disposai of Standing Ttml)er: In 1994, you sold 1,000 reduce the amount received for the purpose of computing cofds of the merchantâWe timber on your 150-acre tract. gain or loss from the sale. The sale price was $22,000 payable ¡n cash on the effective date of the contrad. You had not sold, cut, or Adjusted Basis—^As discussed on page 17, once you have Otherwise deposed of any timber from the property in prior established the original basis of your timber, you must adjust years. You contracted with a consulting forester to cruise, it as needed. For large properties, adjustments may have to mafk, and sell the trees. The consultant charged be made in the timber accounts from year to year to keep 10 percent of the gross sale proceeds or $2,200 for his current the dollar amounts and volumes shown in the $efvicö$. accounts. These annual adjustments should reflect additional timber acquired, timber cut or sold since the last adjustment, You determine your deductible basis for the timbersofd by timber losses claimed on your tax return, and capitalized muÄiptying the depletion unit by the number of units soid. costs as discussed in Chapter V. They should also include The adjusted dollar basis of your timber aocount available transfers during the year from young growth or plantation far depletion as of the end of 1994 was $32,408, The subaccounts to merchantable timber subaccounts, and the adjusted voiume at the end of 1994. after adding the amount of growth since the last adjustment. In addition, the growth that occurred since the last adjustment, was number of units shown in a timber account should be 2,320 cords. The depletion unit was thu$ $13.97 p^t cord, changed to correct inaccuracies or to reflect changed obtained by dividing öie adjusted dollar basis by the standards of utilization. You should additionally adjust adjusted votume. The deductible basis for the siaSe was accounts if you change to a different log rule or other unit of therefore $13,970--determined by multipl^ng the $13.97 measure. All such adjustments should be shown on Schedule depletion unit by l.ooo cord$ (the number of tinit$ $old). F of Form T. At the end of any year in which a disposition The net gain (profit) from the sale was $5,830--determined occurs, but before basis recovery is computed, each timber by subtracting the deductible basis ($13,970) and *e costs account should reflect how much merchantable timber in that of sate ($2,200) from the sale proceôd$. Tlie siowable account was available for cutting. deductible basis ol the timber ^old te reported on Schedule Fof Form T a$ shown in Figure Vl*1, and Ote prof it from the If you own a small tract, and sell or cut timber infrequently, sale is reported on Schedule C ci Form T as ätown m you may need to make adjustments—including those Figure Vtó (the figure shows only part of Schedule C). reflecting growth—only at times of disposal. In the case of a

31 Figure VI-1—Schedule F (Form T) Capital Returnable Through Depletion

Quantity in board feet, log scale, or other unit Ckjst or other basis Line number on Form T (1) (2) 28. Estimated quantity (at end of 1993) 2,100 cords $32,408 30a. Addition for growth (1 year) 220 33. Total at end of 1994, before depletion 2,320 $32,408 34. Unit rate $ 13.97 37. Quantity of timber sold 1,000 38. Allowable as basis of sale $13,970 41. Total reductions during year (a) Sum of lines 35. 37, and 39 (b) Sum of lines 36, 38, and 40 1,000 $13,970 42. Net quantity and value at end of year (1994) 1,320 cords $18,438

32 Form T .Tmben fRev «1-95^ »aae 3 Schedule C Profit or Loss From Land and Timber Sales (Continued) 14a Purchaser s name and address , b Date of saie

15 Amount received: a In cash $22>000.00 b In interest-bearing notes . . 0 In non-interest-beanng notes

16 Amount received m other consideration 17 Explain the nature of other consideration and how you determined the amount shown on line 16 ► 18 Total amount received for property (add lines 15 and 16). ! $22.000.00 19 Cost or other basis of property: Cost or otti«r Total cost or other basis Unit Numb«r of units basis psr unit a Forested land Acre b Nonforested land Acre c Improved land (descnbe) > Acre

Merchantable timber. (Estimate in detail the quantity of merchantable timber on the date of Cords UOOO $13.97 $13.970.00 sale or exchange. Include the quantity of timber in each species of timber by diameter at breast ^ height (DBH) classes. State the log rule used if the unit of measure is thousand board feet (MBR. log scale.)

e Premerchantable timber

f Improvements (list separately)

g Mineral hghts. $13,970.00 h Total cost or other basis 2,200.00 i Direct sale expenses (cruising, marking, selling)

20 Profit or loss (line 18 less the total of lines 19h and 191) $ 5,830.00 Schedule D Losses 21 If you had losses during the tax year from fire, wind, theft, or other causes, and you claimed the loss on your income tax return, show separately the proof of loss for each timber account and complete lines 22 through 25. 22 Cause of loss

23 Location and area of land on which loss took place

24a Total loss before any insurance recovery b Less amount received from insurance c Loss as claimed on tax return 25 Explain in detail how you determined the total loss on line 24a:

Figure VI-2. Schedule C of Form T (Timber). 33 Recovery of Basis—Cutting of Standing Timber—Instead of You cannot claim a depletion allowance for timber cut for selling standing timber that is cut by the purchaser, you may personal use, such as firewood for your home, and you do cut your timber yourself or have someone cut it for you. Your not adjust the dollar amount in the account when you do this adjusted basis may then be recovered by subtracting it from type of cutting. However, if you cut very much timber for the proceeds received from sale of the logs, or from sale of personal use, you may need to adjust the account to reflect products you produce from them. This type of recovery is the decreased quantity that is available for commercial termed timber depletion. Example VI-2 illustrates the recov- cutting or sale. ery of basis when you cut your own timber.

Example Vi-2

Rôdov^ry of ba^te wh^tt you cut standing timbi^r: Ybti cut 500 cords of your timber from the 150-acre tract. The cutting was completed in 1995 ata cost of $7,520 for fuel and depreciatiorr on equipment. However, you could sell only 300 cords by the end of your 1Ô95 tax year. You received $45 per cord for the wood sold. Your depletion unit for the timber eut was $12.89 per cord, determined as shown on Schedule F of Form T (Fig. Vl-3), where the values are carried forward from Example VM, page 31.

You report the profit on the sale of the wood on Schedule C of your Form 1040, as follows:

1995 Income on $ate otwood Proceeds from wood &al6$—^300 cords x $45 per cord) $13,500 Less: Depletion allowance—(300 cords x $12.89 per cord) $ 3,867 Logging expenses—(SCO cords x $15.04 per cord) $ 4,512 Total expenses $ 8,379 Profit on wood sales $ 6.121

If you had elected and qualified under the provisions of Section 631(a). such an election would qualify a portion of the income for capital gain treatment. Section 631 (a) procedures are discussed on page 33.

The wood not sold in 1995 is entered into a wood inventory account» as follows: Ctosing 1995—opening 1996 wood inventory account Volume (cords} 200 Cost: Depletion allow^ce--(200 cords x $12^89 per cord) $2,578 Logging expenses--(200 cords x $15,04 per cord) $3.008 Total $5,586

Determining the Kind of Gain or Loss rates. Today, noncorporate taxpayers are taxed at five levels for ordinary income, with a maximum of 39.6 percent. Standing timber may be treated for income tax purposes as Noncorporate long-term capital gains, on the other hand, are either a capital asset or a noncapital (ordinary) asset. This taxed no higher than 28 percent Ordinary income and long- distinction is critical in determining whether a timber owner's term gains are taxed at exactly the same rates for corporate gain or loss is considered "ordinary" or "capital" in nature and taxpayers. Tables VI-1 and VI-2 reflect how noncorporate and in determining how timber gains and losses are reported. corporate taxpayers are currently taxed.

Prior to 1987 noncorporate taxpayers paid Federal income Capital Gain Status is Still Important—Eyen if your taxable tax on only 40 percent of their net capital gains (that is, the income is low enough so that net capital gains are taxed at excess of net long-term capital gains over net short-term the same rate as ordinary income, it may still be important for capital losses). Since the maximum marginal noncorporate you to be certain that income from the sale or cutting of Federal income tax rate was 50 percent, this meant that the timber qualifies to the extent possible as a long-term capital maximum effective tax rate on net capital gains was only gain. For example, net capital losses may be used to offset 20 percent (40 percent of net capital gain included in income only $3,000 of ordinary income per year, but there is no limit taxed at a 50-percent rate), as compared with a maximum on using capital losses to offset capital gains. Thus, if you rate of 50 percent on ordinary income. For corporations, the have large capital losses from any source, you may be able maximum tax rate was 46 percent on ordinary income, but to deduct a greater proportion of those losses during any year only 28 percent on net capital gains. Thus, both noncorporate in which you have timber capital gains. Also, if you are a sole and corporate taxpayers generally benefited if the proceeds proprietor or partner whose timber holdings are considered to be a business (see page 15), you are subject to self-employ- of their timber sales qualified as long-term capital gains rather ment tax (see page 55) on ordinary income from the busi- than as ordinary income. ness. If your timber proceeds qualify for and are reported as capital gains, however, they will be exempt from this tax. This In enacting the 1986 Tax Reform Act, Congress lowered the is an important consideration, particularly for those timber maximum tax rates on ordinary income and repealed the owners who are retired or semi-retired and who have little or differential between the respective rates at which ordinary no income from wages or salary. The self-employment tax is income and net capital gains were taxed. Since that time, discussed more fully in Chapter IX. however, there have been several additional changes in tax

34 Table VI-1—How Noncorporate Taxpayers are Currently Taxed^

Married taxpayers filing Single taxpayer Estates and trusts Ordinary income Net capital gains joint return Taxable income Maximum marginal tax rate, percent 0-$39.000 $0-23.350 $0-1,550 15 15 $39,000-94.250 $23,350-56.550 $1,550-3,700 28 28 $94,250-143.600 $56,550-117,950 $3,700-5,600 31 28 $143,600- $117,950-256,500 $5,600-7,650 36 28 256.500 $256,500+ $256,500+ $7,650+ 39.6 28 ^ As of 1995. Two other categories of noncorporate taxpayers are not shown in the table—married taxpayers filing separate returns and heads of households.

Table VI-2—How Corporate Taxpayers are Currently Taxed^

Taxable income Maximum marginal tax rate, percent Net capital gains Ord inary income 0-$50.000 15 15 $50,001-75,000 25 25 $75,001-100,000 34 34 $100,001-335,000 39 39 $335,001-10.000,000 34 34 $10,000,001-15,000,000 35 35 $15,000,0001-18,333,333 38 38 $18,333,333+ 35 35 'As of 1995.

Capital Gains from Timber Transactions—\NheXher your the Internal Revenue Code, or (3) by cutting the timber timber gains and losses qualify for capital gains treatment or yourself; converting it to salable products such as logs, not depends on these three factors: pulpwood or lumber; and making a specific election under Section 631 (a) of the Code. If your timber is held primarily for Primary Purpose for Holding the Timber: Standing timber is a sale to customers in the ordinary course of business, capital asset if it is neither used in a trade or business nor generally only the last two methods will provide capital gains. held primarily for sale to customers in the ordinary course of The complexity of tax treatment of revenues and expendi- a trade or business. Gain on the outright (lump-sum) sale or tures associated with timber leases/long-term cutting con- exchange of such timber, if owned for more than the required tracts is beyond the scope of this publication. For information holding period (see below), is a long-term capital gain. on the subject, consult Revenue Rulings 62-81, 62-82, 75-59, Although timber used in a trade or business is not a capital and 78-267. All are summarized in Appendix I. asset, its outright sale may, nevertheless, also result in a long-term capital gain under Section 1231 of the Internal How Long the Timber Has Been Held: To qualify for long- Revenue Code if the holding period has been met. term capital gains, you must have held purchased timber for more than 1 year prior to sale, if sold lump-sum. If disposed How the Timber is Disposed of: You may dispose of your of under Section 631(a) or 631(b), it must have been held for timber in one of three ways, namely (1) by lump-sum sale or more than 1 year prior to cutting. The 1-year holding period exchange, (2) under a pay-as-cut contract where you must also be met when disposing of timber acquired by gift. retainan economic interest as described in Section 631 (b) of However, both the donor's and donee's time of ownership

35 may be counted; thus the holding period with respect to the Example Vi^3 donee may be entirely met before the gift is even made. For inherited timber, there is no holding period required in order Sdte of $tandlnfl timber: You sold 60 thousand board f^ö* to qualify for long-term capital gain status. (MBF) of standing timber ¡n a tump-stim sale on August 10, 1995. The contract prica was $15.000. The timber was Sale of Standing Timber for a Lump Sum located on land purchased on March 1.1Ô74, as part or a farm. Your adjusted basîs in tha timber sold was $2,413, A sale for a lump sum is the outright sale (usually by means computed according to the procedures discussed m tne of a timber deed or sale contract) of standing timber for a $0ctiori "Detorminîn^ tha Amount of <3aln or lo$s." fixed total amount agreed upon in advance. The sale may page 31, and as illustrated m Chapter XIV, Torest cover all timber on a specified tract; or only certain species, Records." Tho State $orvío0for0$t^r martcad and tailed diameter classes, or individually marked trees on the tract. ^e trees sold and estimated the volume. This service was provided frea. Howevar, you paid $325 in (09^1100$ to hav^ Capital gains treatment will apply if the timber is a capital fee contract checked and to cfosa the sale. You ar^ asset in the hands of the seller. Timber will be a capital asset primarily engaged in crop and livestock production on tí^ in your hands if it is not held primarily for sale to customers in farm and seft timber infrequently. The timber should be the ordinary course of a trade or business and is not property considered to be a capital asset in your hands, and the that is used in a trade or business. This means that timber is proceeds therefore reported on Scheduîe D. The sale a capital asset if you are holding it primarily for personal use resulted in a bng-term capital gain of $12,262 (sale or as an investment, as discussed in the section "Types of proceeds of $15,000 les$ $325 for sai^ oxpenses and la$s Forest Ownership and Operation," page 15. Whether timber the allowabîe basis of $2,413). This transactton is entered is held primarily for sale in the ordinary course of a trade or in Part H of Schedule 0 as shown in Figure VI-4. business is not always easy to determine. There is no generally applicable definition of "trade or business" in the « your $aí0 involves paym0rtt$ oxtehding beyond th^ year Internal Revenue Code or in the Income Tax Regulations. of sale, see the discussion of installment salés on page S3. There is also no broadly applicable judicial definition of the phrase. Thus the question can only be answered by weighing Gains and losses from lump-sum sales of standing timber all the facts and circumstances of each particular situation. that do not qualify for capital gains treatment because the Although no single factor is determinative, the following timber was held primarily for sale to customers in the ordinary factors are important: course of business are ordinary gains and losses. If you are a (1) the purpose for acquiring and holding the timber, whether sole proprietor, these have to be reported on a business for sale or investment; schedule, either Schedule C or Schedule F. Other forms are (2) the number, continuity, and frequency of timber sales, as used by partnerships, corporations, trusts, and estates. opposed to isolated transactions; (3) the extent to which you solicit or promote timber sales, as Include an attachment on a plain sheet of paper giving the opposed to merely letting prospective purchasers details of the sale, and showing the calculation of the approach you, and deductible basis, if any. Alternatively, Form Tcan be used to (4) any facts that indicate that timber transactions are part of report this information. your occupation or contribute substantially to your livelihood. In general, if you only make an occasional Disposal of Standing Timber With an Economic Interest timber sale that is unrelated to any trade or business in Retained (Section 631(b)) which you are engaged, the timber will qualify as a capital asset, and the proceeds will thus qualify for capital gains Timber cut under a contract that requires payment at a treatment. specified rate for each unit of timber actually cut and mea- sured, rather than as a lump-sum amount of money agreed If you intend to sell standing timber, and are in doubt about its on in advance, is a disposal with an economic interest capital asset status, you should consider entering into a retained rather than a sale of timber. This type of transaction contract for disposal with an "economic interest retained" (see is often called a "pay-as-cut" contract. It obligates the below). purchaser to cut the designated trees and purchase them at the unit price designated in the contract. Capital gains and losses are reported differently from ordinary income on your tax return. The rules are discussed in The term "economic interest" arises from the fact that the Publication 544, "Sales and Other Dispositions of Assets." To owner has an investment in the timber and secures income report lump-sum timber sales whose proceeds qualify as from its cutting, to which he (she) must look for a return of the capital gains. Schedule D of Form 1040 should be used. investment. The seller usually retains legal title to the trees Nontimber capital gains transactions are also reported on until they are cut and thus bears the risk of any damage to or Schedule D. If the long-term gain holding period has been loss of the standing timber. Advance payments are permitted met, the timber transaction is entered in Part II. If the holding under a Section 631(b) contract. However, in such a case, period has not been met, the information is entered in Part I the contract has to clearly stipulate that, upon completion of (short-term capital gains and losses). The use of Schedule D the cutting, adjustments must be made, as required, in order is shown in the following example. that the total amount paid is determined by the volume of timber actually cut multiplied by the specified unit price.

36 Figure VI-3—Schedule F (Form T) Capital Returnable Through Depletion

Quantity in board feet, log scale, or Cost or other basis other unit (2) Line number on Form T iU 28. Estimated quantity [at end of 1994] 1,320 cords $18,438

30a Addition for growth (1 year) 110 $18,438 33. Total at end of year (1995) before depletion 1,430 $ 12.89 34. Unit rate $ 6,445

35. Quantity cut 500

36. Depletion sustained

41. Total reductions during year

(a) Sum of lines 35, 37, and 39 500

(b) Sum ot lines 36, 38, and 40 $ 6,445

42. Net quantity and value at end ot year (1995) 930 cords $11,993

Figure VI-4—Schedule D (Form 1040) Capital Gains and Losses

(a) description (b) date (c) date sold (d) sales (e) cost or (f) loss (g) gain acquired price other basis Line 9c 60 MBF Timber 3/1/74 8/15/95 $15,000 $2,738 — $12,262

37 Scaling the cut timber is the usual but not the only acceptable Therefore, timber is considered "cut" when, in the ordinary method of measurement. The volume can also be determined course of business, the quantity felled is first definitely by cruising the standing timber subject to the contract. The determined. This means the date of disposal is the date on amount actually disposed of is then the cruised volume which the volume of cut timber is first determined—whether before cutting minus the cruised volume of any contract at a log landing, wood yard, or mill—or after a follow-up timber that was not cut (see the digest of Revenue Ruling timber cruise has been completed. 78-104, page 92). This definition of "cut" could help in determining whether a Two important advantages are offered by Section 631 (b) Section 631 (b) disposal of timber qualifies for long-term contracts. First, the gain realized is treated as a capital gain capital gains status. You may not have owned the timber for regardless of whether the timber was held primarily for sale the required holding period at the time it was felled. But, by as part of a business—even if you are a dealer in timber. the time it was measured, the holding period may have been met. However, the time of measurement cannot be purposely The second advantage is that timber qualifying under shifted merely to obtain a tax advantage. Section 631(b) is Section 1231 property, which means that you are entitled to capital gains treatment when aggregate If you include advance payments on your tax return as capital Section 1231 gains exceed aggregate losses from the gain realized from the disposal of timber, and the cutting right disposition of such property. Section 1231 gains and losses expires, is terminated, or is abandoned before the timber that are reported on Form 4797 and totaled. If a net gain results, it was paid for is cut. you must file an amended return. Such is treated as a net long-term capital gain and is transferred to payments are then treated as ordinary income. Part II of Schedule D. There it is combined with any other long-term capital gains and losses for the year. If the summa- Your gain or loss from a Section 631 (b) timber disposal is tion of Section 1231 gains and losses results in a net loss, determined in exactly the same way as for a lump-sum sale, however, it is treated as an ordinary loss. This means that it is as discussed on page 36. It is reported as a Section 1231 fully deductible from ordinary income in the current year. The transaction on Form 4797, as covered earlier in this chapter. net loss is transferred to Part II of Form 4797 where it is combined with any other ordinary gains and losses for the The Cutting of Standing Timber with an Election To Treat year (see 1RS Publication 544, "Sales and Other Dispositions as a Sale (Section 631(a)) of Assets"). When standing timber is cut by the owner and the logs or Three provisions of Section 631(b) will be discussed in more detail. The first provision concerns the definition of "owner" products manufactured from them are sold, the entire for purposes of qualifying under Section 631 (b). The term is proceeds must be reported as ordinary income unless a broadly defined to include any person or legal entity, including Section 631 (a) election is in effect. However, by making an sublessors and holders of contracts to cut timber. To qualify election under Section 631 (a), you may cut timber for sale or as an owner, you must also have an "interest" in the timber. for use in your trade or business and receive long-term An interest means that you have the right (before entering capital gains treatment on the gain from holding it—just as if into the 631 (b) contract), if you so choose, to cut the timber in you had sold the standing timber outright instead of convert- question for sale on your own account or for use in your trade ing it yourself. In this case, the proceeds have to be divided or business. into two segments: (1 ) the value added to the standing trees by converting them into products, and (2) the gain that The second provision concerns the definition of "timber." resulted from holding the standing timber until the year cut. "Timber" for Section 631 (b) purposes includes the part of Any profit realized from converting standing timber into standing trees usable for lumber, pulpwood, veneer, poles, products is always ordinary income, not capital gain. piling, crossties, and other wood products. Also included are If you elect to use Section 631 (a), and the Section 631 (a) evergreen trees that are more than 6 years old when severed holding period has been met, the transaction is reported in from their roots and that are sold for ornamental purposes, two parts, as follows: such as Christmas trees (see Chapter X). Section 631(b) (1 ) Report as a Section 631 (a) gain or loss the difference does not apply to evergreen trees sold in a live state (such as between the adjusted basis for depletion of the timber balled and burlapped Christmas trees), whether or not for that was cut and its fair market value as standing timber ornamental purposes. Tops and other parts of standing trees on the first day of the tax year in which it was severed. utilized separately from the main stem are not considered as This is treated as a Section 1231 gain or loss that is either evergreen trees or timber for purposes of netted with other Section 1231 gains and losses you may Section 631(b). They may, however, be considered as have, and net gain is treated as long-term capital gain. 'limber" if utilized as part of the tree as a whole in the (2) Report as ordinary gain or loss the profit or loss resulting manufacturing process. The term "evergreen" is used in the from conversion of the standing timber into products, commonly accepted sense and includes pine, spruce, fir, such as sawlogs or pulpwood. The profit or loss is hemlock, cedar, and other coniferous trees. determined just as for any other business operation. The income received from the sale of the products is reduced The third provision concerns the date of disposal. This is by the cost of the timber plus the cost of converting it. the date the timber is cut. However, it is not usually practical The cost of the timber is the fair market value described to measure timber in the woods as the trees are severed. in (1) above.

38 Six aspects of Section 631 (a) will be discussed in more The holding period under Section 631(a) runs from the date detail—the meanings of owner, timber, timber use, holding you acquired the timber or the contract right to cut it to the period, fair market value, and how the election to use Section date it is actually cut. As explained on page 38, timber is 631 (a) is made. An owner for Section 631 (a) purposes is considered cut when, in the ordinary course of business, the essentially the same as for purposes of Section 631 (b). For quantity felled is first definitely determined. purposes of 631(a), an owner is any taxpayer who has owned or held a contract right to cut timber for the required holding The fair market value used as the sales price is that price at period. In order to have a contract right to cut timber, you which the standing timber that was felled would have must have the unrestricted right to sell the timber cut under changed hands between a buyer and a seller on the first day the contract or to use it in your trade or business (see digest of the tax year (usually January 1) in which the trees were of Revenue Ruling 58-295, page 92). This means that if you cut, assuming that both parties had reasonable knowledge of were, for example, a logger who bought timber under a all the necessary facts and neither was required to buy or cutting contract, you would be the owner of that timber for sell. The trees must be valued as they existed on the first day Section 631 (a) purposes just as if you had outright title to it, of the tax year regardless of any changes that occurred to or to the land and timber together. them between that date and the date of the actual cutting.

If, however, you have only a contract to cut timber and must The best indicators of fair market value are the actual prices deliver the logs back to the owner or to a buyer specified by paid for similar timber in the area in which the timber being the owner, you are merely performing a logging service and valued was located. Such prices, however, have to be do not qualify as an owner or holder of a contract right to cut adjusted to account for any differences between the condition timber. A logging service contract that uses the terms "buy" or of the trees being valued and the markets for them, as "sell" or "stumpage charge" will not meet the requirement to compared to the timber for which actual prices are known. have a contract-right-to-cut in order to be considered an The fair market value used must be for the actual trees cut; owner of the timber. they must be valued on their own merits and not on the basis of a general average for the region. Among the factors to be Timber for the purposes of Section 631 (a) is defined exactly considered are the following: the same as for Section 631 (b). (1 ) The character and quality of the timber as determined by species, age, size, and condition. To qualify under Section 631 (a), the trees must be cut for sale (2) The quantity of timber per acre, the total volume under or for use in your trade or business, not for personal use. This consideration, and its location with reference to available includes timber cut and sold as rough products (logs, markets. pulpwood, fuel wood, etc.) or cut and used in a conversion (3) The accessibility of the timber from the standpoint of the business such as sawmilling. "Timber cut by taxpayer" probable cost of cutting and transportation. includes what you personally cut, as well as trees severed by (4) The competition likely to develop from other timber other persons who do so at your direction. buyers.

Example VM

Etection to treat cutting as a salo: You file your tax return on a calendar year basis, and you cut 60 MBF ot timber . during 1995 from a tract purchased in 1979, The sawTogs were |wTed at the roadside and sold, also In 1995, You received $18,000 tor the togs. The fair market value of the standing tinrber that was cut was $260 per MBF, or $15.600, as of January 1,1995, Your basis in the timber cut (determined as explained in "Determining the Amount of the Gain or Loss/ pag0 31 ) was $2»460. Your logging and skidding oo$t$ totaled $1,800. Sinco you bad owned the timber cut lor mor^ than one year» you ôlect to report the cutting tinder Sectton BSIfa). You determine the gain or los$ on the cutting of the timber $eparately from the gain or loss from the sale of the sawtogs, as follows:

Gain from cutting— Fair market value as of January 1, 1995, of timber ojt during 1995 $15,600 Less: Allowable basis , g.46Q Section 1231 gain $13,140 Gain from safe of sawlogs at roadside- Proceeds from sale of sawtogs $18,000 Less: Fair market value as of January 1,1995, of timber cut and sold during 1995 (depletion allowance) $15.600 Logging costs 1.800 Cost of logs sold $17.400 $ 600

You have a $13,140 gain to report with any Section 1231 gains or losses on Form 4767, Part L You also have irtcorti^ ¿f $18,000 and expenses of $17,400 to report on either Schedule C or Schedule F of Form 1040* How to report Sect- bn 1231 gains and losses on Form 4797 was discussed on page 38.

39 If you cut only a relatively small amount of timber during the Example VI-4 illustrates how to determine the two parts of the year, you may be able to estimate its value by obtaining price gain realized under a Section 631 (a) election. information from mill operators and timber buyers in your area. However, if you cut a large amount, you should Government Program Payments probably obtain an appraisal by a qualified timber appraiser such as a consulting forester. Generally, a taxpayer who receives a cost-share payment from Government must report its value as gross income You elect to use Section 631(a) by merely computing your unless a specific exclusion is provided by law. Under Sect- taxes according to its provisions. You indicate the election by ton 126 of the Internal Revenue Code, all or part of certain answering the question in item 44 and supplying the informa- Government cost-share payments made to landowners under tion asked for in items 45 through 51 of Schedule F of Form T approved conservation programs may be excluded from (see Appendix III). The election must be made on the original gross income. This provision has been available since 1979. tax return (including extensions) for the year to which it applies, and not on an amended return forthat year. In general, a portion or all of a cost-share payment is excludable from taxable income if two conditions are met: An election under Section 631 (a) is binding with respect to all (1 ) the payment is determined by the Secretary of Agriculture eligible timber you cut in the year of the election and in all to be made primarily for the purpose of conserving soil subsequent years. The basic rule of discontinuance is that and water resources, protecting or restoring the environ- consent must be obtained from the 1RS. This permission may ment, improving forests, or providing a habitat for wildlife; be given only where there is a showing of undue hardship and and—if given—consent to reelect must also be obtained. The (2) it is determined by the Secretary of the Treasury or the 1986 Tax Reform Act, however, contains a special rule that Secretary's designate as not substantially increasing the permits timber owners who had been cutting under a annual income derived from the property. Section 631 (a) election with respect to a tax year beginning before January 1,1987, to revoke it one time, and reelect one According to Section 126, and the 1RS regulations for time, without such permission. Since the tax rate differential Section 126, nine Federal conservation cost-sharing pro- between ordinary income and net capital gains has been grams and some State programs where payments are made eliminated for some taxpayers, revocation may be advanta- primarily for certain conservation or environmental purposes geous in the event cut timber is not sold in the same tax year meet the above requirements. Federal programs that most in which it is severed. Without the revocation, you will be often affect timberland owners include the Forestry Incentives taxed in the year of cutting on the timber's gain in value as Program (FIR), the Agriculture Conservation Program (ACP), stumpage, even though no income has yet been realized and the Stewardship Incentive Program (SIP). SIP was from the sale of the products. For some owners, however, it recently approved for those SIP practices carried out in small may, as discussed earlier in this chapter, be more advanta- watersheds (see summary of Revenue Ruling 94-27, geous to retain capital gain status rather than revoke the page 92). Since new programs are occasionally added to the election. The one-time revocation permitted by the 1986 Tax list, you should check with the 1RS, your State forestry office Reform Act can be made by simply attaching a statement or the local office of the USDA Consolidated Farm Service made on a plain sheet of paper to the tax return for the year Agency (CFSA), formerly Agricultural Stabilization and in which the revocation is to be effective. Conservation Service (ASCS), to see if a particular program qualifies. Reporting requirements under Section 631(a) are the same as for Section 1231 gains and losses in general and for any The regulations for Section 126 specifically eliminate any other income realized from a trade or business. The gain or Government payment that is in the nature of rent or compen- loss on the standing timber is reported on Form 4797 with sation for services from qualifying for exclusion from gross other Section 1231 transactions for the year, as discussed on income; therefore, recurring annual payments under the page 38. The profit or loss from the sale of the cut products is Conservation Reserve Program (CRP) do not qualify for reported by sole proprietors on a business schedule—either exclusion. CRP cost-sharing payments also are always Schedule C or Schedule F of Form 1040. Other forms, as reportable as income; they are never eligible for exclusion. applicable, are used by partnerships, corporations, trusts, But reforestation costs incurred under the CRP are eligible for and estates. The cost of the timber cut (the fair market value the amortization and credit as discussed in Chapter V, used for computing gain or loss) and the expenses of cutting including the expenditure of cost-share payments received. and sale are listed as "other" expenses on Schedule F or Also, as an alternative to the amortization and credit for those Schedule C. taxpayers who are engaged in the business of farming, some or all of the reforestation expenses incurred for CRP planting An attachment giving the details of the cutting and sale may be deductible annually under Section 175 as discussed should be included with your tax return. Attach Schedule F of on page 24. Form T or provide the information required by Schedule F on a plain sheet of paper attached to your tax return. Be certain Based on Section 126 and the regulations thereunder, there to include the details of how the depletion basis that was are two options for reporting cost-share payments for Federal used, if any, was determined. Also include the information income tax purposes: that was used to estimate the fair market value.

40 Example VI-5 option 1 : Exclude all or part of the cost-share payment from gross income. Last year a taxpayer hawested Í 00 acre$ ^nd mcm^d '-■ Option 2: Include the cost-share payment in your gross $t20,000 for the timber. This was the first income the income. The procedure for computing the excludable portion taxpayer had obtained from the property tor mâriy yeari^. of the cost-share payment is explained in the following This year he replanted the 100 acres at a total cost of paragraph. However, you may elect to include the payment in $15,000 ($150 pBt acre). To help cover thecoSi of thé your gross income even if you are eligible to exclude it. In replanting, he had applied for and received a Government some cases, inclusion may provide a tax benefit. cost-share payment of $10,000. How much of thte $10*000 Determining the Exciudabie Amount payment can be excluded from his gross income?

The regulations for Section 126 provide that the maximum Computing the excludable portion: amount of a cost-share payment that can be excluded from Step 1 : (1 ) Compute 10% of average annuat Income for tti0 gross income is 'Ihe present fair market value of the right to three previous years; receive annual income from the affected acreage of the $120,000/3-$40,000 greater of: (1)10 percent of the prior average annual income $40.000 X.10« $4,000 from the affected acreage, or (2) $2.50 times the number of (2) Compute $2.S0 times the affected acre- affected acres." In other words, the excludable portion is that age(100}: portion not substantially increasing income from the property $2.50 x1(X)« $250 concerned. Prior average annual income is defined as the Step 2: Compute th0 präsent v^ue of the larger amount average of the gross receipts from the affected acreage for from Step 1. Assume the interest rate used to the last 3 years preceding the tax year in which installation of compute th0 present vaiue Is /% (tfie applicable the improvement is commenced. mid-term federal rate for October 1994 is 7.10%). $4,00OAO7^ $57,143 1RS regulations do not spell out in detail how to calculate the SiSaS: Compare the payment to the computed value: "present fair market value of the right to receive annual $10,000 is less than $57,143, thus the entire income." A common method of determining the present value payment ($10.000) can be excluded from gross of the right to receive annual income over an indefinite period income. is to capitalize it (i.e., divide the annual income by an appropriate interest rate). Also, the 1RS regulations do not Example VI-6 specify an appropriate interest rate to use. However, a procedure is specified in the Internal Revenue Code for Assume the taxpayer did not have any income from the valuing farm and forest lands for estate tax special-use property In the last 3 years. This year he received a cost- valuation purposes, which divides annual income by the share payment of $10,000 for ímpíementíng approved Federal Land Bank (now Farm Credit Bank) interest rate (IRC conservation practices on the 100-acre woodlot. How much Section 2032A (e)(7)(A)). Although this procedure does not of this $10^000 payment can be excluded from hfs gross apply to Section 126, it has been informally accepted by the income? 1RS. The interest rate used for calculating the present value will strongly affect the amount that can be excluded. The Computing the excludable portion: lower the interest rate used, the larger will be the exclusion. The following procedure shows a step-by-step approach for Step 1 : <1} Compute 10% of average annual income computing the excludable portion: $0/3 « $0 Step 1 : Compute the following two values: $0X,1Q«$0 (1)10 percent of the average annual income derived from (2) Compute $2.50 times the affected acreage the affected acreage prior to the improvement. (100): (2) $2.50 times the number of acres affected by the improve- $2.50 XI00 «$250 ment. SiêStZ'' Compute the present value : Step 2: Calculate the present value of the larger of the two $250/.07 ^ $3.571 values from Step 1. SigßjJ: Compare the payment to the computed valué: Step 3: Compare the cost-share payment to the value $10,000 IS greater than $3,571, thus only $3,751 computed in Step 2. can be excluded fiom gross income. The remain- (1 ) If the cost-share payment is less than or equal to the der of $6,429 ($10,000 - $3,571) must be included computed value, it may be entirely excluded from gross in gross income,.. . income. (2) If the cost-share payment is greater than the computed If you decide to exclude part or all of a cost-share payment value, only an amount equal to the value from Step 2 can from gross income, attach a statement to your tax return be excluded from gross income. The remainder must be stating specifically the amount of the cost-share payment you included In gross income. received, the date you received it. the amount of the cost- sharing payment that qualifies for the exclusion, the amount you choose to exclude, and how you determined that amount.

41 Including Cost-Share Payments in Gross Income also applies to products derived from the trees as they stand, such as gum naval stores, maple syrup, fruit, nuts, bark, and After determining the excludable amount of the cost-share Christmas greens. Gains from the sale of trees for landscap- payment, the nonexcludable portion must be reported as ing purposes, such as balled nursery stock, are also ordinary gross income. Cost-share payments received by individual income. taxpayers that are included in gross income are reported as miscellaneous income on the first page of Form 1040, or on Tree stumps from cutover land are sometimes an exception. Schedule C or F of Form 1040, depending on your particular If you make a lump-sum sale of tree stumps from cutover tax status. That part of a cost-share payment included in timberland acquired for investment, you may be entitled to gross income may be subject to the self-employment tax, treat any gain from the sale as a capital gain (see summary because self-employment income generally includes all items of Revenue Ruling 57-9, page 93). However, you rnust sell all of business income—including Government conservation the stumps on the property at one time. Capital gains cost-share program payments. The self-employment/social treatment does not apply to gains from the sale of stumps by security tax is discussed in more detail in Chapter IX. persons in the timber or stump business—either as a buyer. seller, or processor. Therefore, proceeds from the sale of tree To the extent that a cost-share payment is included in gross stumps by timber operators after the trees have been income, and is used for planting or seeding of trees for han/ested are ordinary income. commercial production of timber products, it may qualify for the 7-year reforestation amortization and the 10 percent Gains from the sale of limbs and tops that are left after reforestation investment tax credit under Sections 194 and 48 logging are also ordinary income, even if the timber was of the Internal Revenue Code as discussed earlier in subject to a Section 631 (a) election. Chapter V. A detailed explanation of the reforestation amortization and credit can be found beginning on page 19. Information Returns

If the cost-share payment received is used for timber stand When you sell or dispose of standing timber, the purchaser improvement practices, it must always be included in gross may file a Form 1099 (information return) with the Internal income. However, it is then generally eligible for deduction as Revenue Service. The Form 1099 reports the gross proceeds a current expense in the year expended—subject to the paid to you for your timber. You will also be sent a copy of the passive loss rule limitations as discussed in Chapter V. Form 1099. Purchasers of timber under a lump-sum sale are not required to file a Form 1099, although many will do so. Recapture Provisions Purchasers under a Section 631(b)-type contract are required to file one, however. Whether or not you receive a Form 1099 If the property established with an excluded cost-share with respect to your timber sale, you must report the sale payment is disposed of within 20 years of establishment, proceeds as discussed earlier in this chapter. Government recapture provisions apply. The recapture amount during the agencies who make cost-share payments to forest landown- first 10 years is the lesser of: (1 ) the amount of gain from the ers also are required to file information returns with the disposal, or (2) the amount of cost-share payment excluded. Internal Revenue Service, reporting the amounts of the It is recaptured as ordinary income. This base recapture payments. These payments should be treated for tax pur- amount is reduced by 10 percent for each year or portion of a poses as discussed earlier in this chapter. year if disposal occurs between 10 and 19 years. 1RS Form 4797 is filed to declare the recaptured amounts as income.

Other Timber-Related Receipts

Ordinary gains or losses result from the sale of products produced from timber. This rule applies to all products derived from harvested trees such as logs, lumber, pulpwood, poles, mine timbers, crossties, fence posts, fuelwood, and chips. It

42 Chapter Vil. Casualties, Thefts, and Condemnations

If part or all of your timber is destroyed or stolen, or if your Physical losses of timber will generally come under the forest land is condemned for public use, you may be entitled heading of casualties, that is, losses caused by naturaj or to claim a deduction on your income tax return. These types other external forces acting in a sudden, unexpected, and of bsses are termed involuntary conversions. To do this, you unusual manner. A sudden event is one that is swift, not need to know the kinds of losses that are deductible, the tax gradual or progressive. An unexpected event is one that is and business structure of your activity, how to determine the ordinarily unanticipated and one that you do not intend. An amount of loss recognized for tax purposes, and how to unusual event is one that is not a day-to-day occurrence and determine the type of deduction-capital or ordinary. The one that is not typical for the activity in which you were nature of the deduction also depends on your purpose for engaged when the damage or destruction occurred. holding the timber. If, because of salvage operations, insurance recovery, or other compensation, the destruction, Noncasualty Losses theft, or condemnation results in a gain, you must include the gain in your income, unless you elect to postpone reporting A deductible noncasualty loss may result if the precipitating such gain, as explained later in this section. The passive event is unusual and unexpected. The suddenness test does activity loss restrictions, discussed beginning on page 28, not have to be met. Circumstances generating noncasualty generally do not apply to casualty and theft losses. losses are contrasted with casualty losses in the discussion below. Operating losses, discussed in Chapter V, are created when expenses associated with a trade or business, or an invest- Casualty Losses ment activity, exceed income in a tax year. Such losses do not involve the involuntary conversion of property discussed Casualty losses include but are not limited to those resulting in this section. from fire, hurricane, or other casualties such as windstorm, sleetstorm, and hail. Casualty losses also include destruction The three basic categories of involuntary losses—physical or damage from plane crashes, automobile accidents, and damage or destruction, thefts, and condemnations—are similar events. discussed in this chapter. Note that under certain circum- stances a deductible loss results from the destruction or Disease or Insect Infestation—Trees grown for timber that damage to property held as part of a trade or business or for are killed by disease or insect infestation do not ordinarily the production of investment income even if the loss is not result in a casualty loss. Losses resulting from a low level of caused by a "casualty." Since losses resulting from theft pest incidence, usually present under normal conditions, are (sometimes referred to as "timber trespass") and condemna- not deductible. If the trees killed are shade trees, the sudden, tion of property for public use are treated similarly to casualty unexpected, and unusual damage resulting from the southern losses, the discussion focuses on casualty losses first. The pine bark beetle or other species of insects may be deduct- unique aspects of thefts and condemnations are then- ible as a casualty loss (see summary of Rev. Rul. 79-174, discussed separately. page 94). In addition, some attacks of southern pine bark beetles or other species of insect may result in an unex- Discussion Limited to "Timber" pected and unusual noncasualty loss of timber, which gives rise to a deductible loss (see summary of Rev. Rul. 87-59, This publication discusses timber held for the production of page 94). income as either a business or investment. If your timber is held for personal use see the discussion of "Restoration of Drought Loss—A casualty loss does not usually result when Landscaping" in 1RS Publication 547 "Nonbusiness Disasters, trees being grown for timber are killed by drought. In some Casualties, and Thefts." You should consult 1RS cases, however, drought losses may result in an unexpected Publication 547 for the treatment of losses involving shade and unusual noncasualty loss, which is deductible (see trees. summary of Rev. Rul. 90-61, page 94).

Normal Losses Not Deductible Loss of Potential Income Is Not Deductible—A loss of future profits is not deductible. For example, if an ice storm To be allowed as a deduction, a loss must be evidenced by a damages standing timber and reduces its rate of growth or closed and completed transaction fixed by an event or the quality of future timber, the loss is not deductible. The identifiable events and must actually have been sustained same is true for site damage. To qualify as a casualty, the during the tax year. Timber lost due to natural factors typically damage should cause existing timber to be unfit for use. associated with timber stands, referred to as natural mortality, is not a casualty loss. Natural mortality includes trees killed Combinations of Factors—Combinations of factors some- by overtopping of larger, faster growing trees; normal levels times cause timber damage. A nondestructive fire may be of disease and insect infestations; and low rainfall. Natural followed by insect attacks. Trees weakened by interior rot or mortality is reflected in your timber volume accounts, as characterized by shallow root systems may be uprooted or discussed on page 18.

43 broken off as a result of repeated windstorms or may die as a amount allowable as a loss. The volume used to calculate the result of drought. When combinations of factors are involved, depletion unit for the tass should include adjustments for it may be necessary to consider the length of time from the growth for the year of the casualty but is not reduced by the precipitating event to the eventual loss of the timber to volume of timber destroyed. If the timber has no basis, you determine the suddenness of the loss. will not have a deductible loss.

Salvage Requirement—Every reasonable effort should be Yearof Deduction—A loss arising from a casualty generally is made to salvage the affected timber. A reasonable effort deducted in the year in which the casualty occurs. This is true includes offering the damaged timber for sale. You should use even if you have not yet settled a reimbursement claim or the same marketing procedures as for any other timber sale. have not received an agreed upon insurance settlement or The market value may however, be lower depending on the other compensation. If a claim for reimbursement has been extent of damage to the timber, the volume of damaged made, and you think you will recover all or part of the loss timber on the market, and increased harvesting costs. If you even though you have not yet received payment by the time do not normally harvest your own timber, you would not be the tax return for the year of the casualty is due, reduce the expected to do so in order to recover some of the value in reported loss by the amount you expect to recover. If you damaged timber for which you cannot find a buyer. If you are later recover less than the amount you estimated, you may not able to salvage the timber after making a bona fide deduct the difference for the year in which you become attempt to do so and claim a loss deduction, you should certain that no more reimbursement or recovery can be keep a record of your efforts in order to show that the timber expected (see Example VII-1). was not salvageable. E)ciimpte VIM When losses of this character are heavy but the timber is not salvageable, you should adjust your timber account to reflect Adiustment of loss deduction claimed: Umber that yo^ the loss of timber volume as an offset against growth in ownad wa$ destroyed by tir^ In 1094 The fir^ w^ acciden- computing the depletion unit. tally started by a contractor working on the property. TTie ailowâibte faa$îs of lh0 timber destroyed was $$.5öo. and Determining the Amount of Deductible Loss—If your you expected to recover $3,500 of the IôSô from the timber is destroyed by fire or other casualty, your deductible <îontrector*$ liability insurance. Even though the insurance loss is the allowable basis in the timber destroyed less any company does not make payment to you in 1994, your lo$ö insurance or other compensation received (see summary of for 1994 is limited to $2.000, the difference between the Rev. Rul. 66-9, page 93). Timber damaged but not made lose and the amount you expect to recoven In Í 995, the unmerchantable should be salvaged if possible, as explained company offers to settle the claim for ^^,000 and you above. If a gain results from the salvage activity, there is no accept. The $500 diftorence between the amount you casualty loss with respect to the salvaged timber. Determine expected and what you actually received may be daimed your gain or loss from the salvage cutting, sale, or other aa a ca$ualty loss on your return for 1995> disposal as you would for timber sales in general. Report as income any reimbursement for more than the Determining Volume of Timber Destroyed—To claim a loss amount expected. If, after you have claimed a deduction for a deduction, the single identifiable object damaged or de- loss, you receive reimbursement for more than you estimated stroyed must be identified. For timber, this is expressed in would be recovered (but not more than the total amount of terms of the specific units destroyed. The units of measure- the loss computed), you must include such excess as income ment used should be those utilized to maintain your timber on your return for the year received. Do not file an amended accounts, such as board feet, cords, or cubic feet. return for the year in which you claimed the deduction (see Example VII-2). The number of units of timber destroyed must be established by fair and reasonable measurement to justify a deduction. ExannpleVII-2 You may wish to employ a consulting forester to cruise the timber if the area is extensive and much work is involved. In Adjustment ot loss deduction oiaimed: Timber that you some cases, however, the local representative of the State owned was destroyed by fire in 1994. For tax purposes, forestry agency may be able to furnish you with an estimate your loss from the casualty was $5,000. and you estimated of the quantity destroyed. that insurance would cover $4,500 of the loss. You there- fore claimed a toss of $500 on your 1994 raturn. In 1995 Determining Basis of Timber Destroyed—DeXemme the basis the insurance company pays you $5,250^ or $250 more of timber destroyed as you would for a sale or other disposi- than you estimated in computing your deductible toss for tion, as discussed in "Determining the Amount of Gain or 1994. The $250 difference is included as income on your Loss,** page 31. return for 1995,

First determine the depletion unit by dividing the adjusted Destruction of Unmerchantable Timber—The destruction of a basis for depletion as shown in your timber account by the premerchantable plantation or stand of naturally regenerated quantity of merchantable timber in the account. Then, multiply young growth may result in a deductible casualty loss. You the depletion unit by the number of units destroyed to find the can claim a loss only if (1) you maintain separate plantation

44 or young growth accounts, as explained in "Timber Accounts," the value of the property if: (1) such costs are necessary to page 18, and (2) you have costs allocated to such accounts restore the property to its precasualty condition, (2) the (see summary of Rev. Rul. 81-2. page 91). In addition, under amount spent for restoration is not excessive, (3) the ex- certain circumstances the death of newly planted seedlings penses do no more than take care of the damage suffered, due to an unusual and unexpected drought may qualify as a and (4) the value of the property after restoration is not more noncasualty loss (see summary of Rev. Rul 90-61, page 94). than its value before the casualty.

If these requirements are satisfied, generally you may figure Theft Losses your allowable basis for the unmerchantable timber destroyed by dividing the cost shown in the account by the number of Determine the amount of loss you can claim from a theft of acres in plantation or young growth, and then multiplying that timber, frequently referred to as 'limber trespass," as you amount by the number of acres destroyed. would for a casualty loss. Your deductible loss is the allow- able basis of the timber stolen—that is, the depletion unit Buildings and Equipment—\i buildings and equipment used in multiplied by the number of units stolen—less insurance, your business or held for the production of income (invest- damages, or other recoverable amounts received. ment) are totally destroyed, your deductible loss is the adjusted basis of each specific item of property destroyed, Year Deducted—Generally, theft losses are deducted in the less salvage value less any insurance or other compensation year the theft is discovered. To establish a theft loss, you do received or expected to be received (see Example VII-3). If not have to prove when the timber was stolen, only that the such property is only partially destroyed, your deductible loss theft occurred, that you owned the property, and when you is limited to the lesser of your adjusted basis reduced by any discovered it. Thus, the quantity of timber used in determining compensation you receive, or the decrease in the fair market the depletion unit is the quantity at the time the theft was value of the property reduced by any compensation (see discovered. Example VII-4). Reduce Theft Loss by Anticipated Recovery—Your theft Example Vil-3 loss must be reduced by any amounts you expect to receive as a result of the theft. This is required even though you do Loss when properly Is totally destroyed: Your portable not receive payment until after the close of the tax year. If you sawmiH was completely destroyed by a tire and you carried later recover less than the amount you estimated, you may no insurance on the property. The adjusted basis for deduct the difference for the year in which you became depredation of the sawmill building and equipment at the certain that no more reimbursement or recovery can be time of the fire was $6^500. and its fair market value was expected. Also, if you are reimbursed in a later year for more $5,000. The valu0 of th0 equipment after the fire wa$ only than you anticipated when you estimated the amount of the scrap value, amounting to $300. Your deductible casualty deductible loss, include the excess as ordinary income on io$$ 1$ $6»200, the adjti$ted bast$ erf $6,500 le$s salvage your return for the year in which you receive it, as discussed value of $300. with respect to casualty losses.

Example VH*4 Multiple Damages—In many States, successful prosecution of timber trespassers results in the awarding of compensation Loss when property Is partially destroyed: Assume that to the victim. The award is sometimes two or three times the the sawmill in example VI1-3 was damaged by the fire but .. fair market value of the timber stolen. In the case of double or not completely destroyed. Just before the fire the sawmill . treble damages, one-half, or one-third, respectively, of the had a fair market value of $5,000 and immediately after the award represents compensation for the timber stolen. This fire it$ fair market value was $3,500. Under these facts» amount should be reported as proceeds of an involuntary your foss is limited to $1,500, the decrease in the fair conversion. The gain is determined as for any other disposal. market value, since this amoum is less than the adjusted The other one-half or two-thirds, representing a damage basis of $6,500. award, is fully taxable as ordinary income. It must be reported as "other income." An attachment explaining the entries made Had the fair market value of the sawmill been $8,000 just on your return should be filed with the return. before the fire and $1,000 just aftenA/ard, the decrease ¡n fair market value would be $7,000 and your deductibfe Condemnations casualty bss would be limited to your $6,500 adjusted basis in the property. A condemnation is the lawful taking of private property by a ■■i^k»»««».««.«^^—■—^—«—■—■•—■—■^^—■'^^"■'^^^■■■"■"^^^^^^^^"^ government body for public use without the consent of the Determining the Decrease in Fair Market Value—l\\e owner, but with payment of compensation. The tax conse- decrease in the fair market value of property resulting from a quences are the same if you sell property under the threat of casualty should be determined by an appraisal of the values condemnation. Therefore, if the public condemning authority of the property immediately before and immediately after the tells you that it intends to acquire your property by negotia- casualty. The decrease is the difference between these two tion, or if necessary by condemnation, and you sell the values. Your cost of restoring and cleaning up after the property to the authority at a mutually agreeable price, treat casualty may be acceptable as evidence of the decrease in the sale as if your property had actually been condemned and you were granted an award.

45 The computation of your gain or loss when your forest land is Casualties and Thefts—Appraisal, timber cruising, and condemned or sold under the threat of condemnation will in other ordinary and necessary expenses for determining your all cases involve the land, but may or may not involve loss are expenses in determining your tax liability. They are standing timber, depending on whether you are permitted to not part of the loss, but may othen/vise be deductible (see harvest it. Determine the basis of your timber as you would Chapter V). for an ordinary sale. Your land account should show the part of the original basis that was allocated to land, exclusive of Condemnations—Legal, appraisal, timber cruising, and timber and any improvements (see page 18). The basis of the other expenses incurred to receive a condemnation award land condemned or sold under threat of condemnation is its are deducted from the award to determine the net award basis as shown in the land account (see Example VII-5). reported on your return.

ExómpteVIi-S Postponing Gains From Involuntary Exchange

Cond^mhditlort: You pardmased á Sù-act^ timber trad and You may be able to defer gains realized from a forced allocated $2Û0 per acre^ or $1 O^OQQ, to the {and account, A disposition of timber as a result of an unexpected and strip oí land totaling 5 acres and running through Äe unusual event, such as when the trees are killed by fire or an property was condemned for ^se in building a new high- insect attack of epidemic proportions, or downed by high way. The basis of the tend (exdusive of timber} to be used winds, earthquake, fire, ice storms, or volcanic eruption. in computing the gain or loss on the condemnation is These events generally require a conversion of the timber 5/50thö of $10,000 or $1,000. soon after the event or you will suffer a complete loss of it. To defer any gains realized you must use the proceeds (amount Condemnations for Right-of-Way Easements—Condem- realized) to purchase qualifying replacement property (see nation of forest land for utility or other right-of-way easements summary of Rev. Rul. 80-175, page 94). Amounts realized generally involve the taking of any timber growing on the from the involuntary conversion of timber include the amount right-of-way and the right to grow future timber crops thereon, realized from a lump sum sale of the timber, the amount but not legal title to the land. In the case of power lines or realized under Section 631 (b) in the case of disposition of the pipe lines, the landowner may be allowed to grow crops on timber under a pay-as-cut contract, and the fair market value the right-of-way. The production of timber is generally not under Section 631 (a) in the case of cutting of the timber by allowed because the tops and roots would interfere with the the taxpayer. The purchase of qualifying replacement power lines or pipe lines. Any loss of future timber income property includes the purchase of replacement timber sites; should be included in the negotiations for the condemnation the cost of seeds and seedlings; your costs to plant the trees award. No deduction is allowed for future timber income or sow the seed on currently owned, leased, or replacement foregone. The award received is reported as described on timber sites; and the cost of purchasing stock in the acquisi- page 47. tion or control of a corporation owning timber, timberlands, or both. Basis for Figuring Gain or Loss—The basis of the timber condemned is your depletion unit multiplied by the number of An involuntary exchange occurs when your property is units standing on the property condemned, or by the number completely or partially destroyed, stolen, requisitioned, of acres times the basis per acre for plantations or stands of condemned for public use, or disposed of under the threat or young growth. If, however, the condemning authority allows imminence of condemnation and you receive insurance or a you to han/est the merchantable timber before the land is condemnation award. Involuntary exchanges are also called taken, and you sell the timber, or cut and sell the logs or other involuntary conversions. If you have a gain resulting from an products, only the land would be involved in the computation. involuntary exchange, you may elect to postpone paying tax The gain or loss on the timber would be reported separately on all or part of the gain even though the involuntary ex- as described above. change may not necessarily qualify as a casualty. This occurs, for example, when damages are awarded by court Condemnation of property for public use can raise many order, or when parties who have damaged your property specialized questions. For example, besides receiving an make a voluntary settlement. An example would be a award for your condemned property, you might also receive settlement made by a logger working on property next to severance damages or consequential damages resulting yours who inadvertently removed timber from your side of the from a decrease in value or damage to that part of your property line. property not condemned. A condemnation might also result in a special assessment being charged to you because of Determining the Gain—A gain is realized on an involuntary resulting improvements to your retained property. For a conversion when the salvage sale proceeds, insurance, detailed explanation of the treatment of these special condemnation award, or other compensation that you receive problems, see 1RS Publication 549, "Condemnations and is greater than your basis in the property. The amount of the Business Casualties and Thefts." gain is determined as described above for casualties, thefts, and condemnations. If you salvage your involuntarily con- Recovery of Expenses verted timber by harvesting it instead of disposing of it on the stump, and a Section 631 (a) election is in effect, the amount Expenses are handled differently for casualties and thefts of the gain, if any, is based on the fair market value of the than they are for condemnations. stumpage cut as described on page 38. Ordinarily, you would

46 include the gain from an involuntary conversion in your Reporting Gain or Loss—Property Held for 1 Year or Less— income for the year it is realized. However, under certain Short-term losses (held 1 year or less) on business, rental, or conditions, you may defer the gain or a portion of it until you royalty-producing property are combined on Form 4684 with sell the replacement property you bought with the proceeds. your short-term gains from casualties and thefts. The The amount of the gain qualifying for deferment cannot resulting net gain or loss is reported on Form 4797. exceed the fair market value of the assets converted. Reporting Gain or Loss—Property Held for More than Requirements to Postpone Gain—Your gain is not taxed in 1 Vfear—Long-term losses (held more than 1 year) on the year realized if within the allowable replacement period business, rental, or royalty-producing property are combined you purchase other property that is similar or related in with your other long-term casualty and theft losses on Form service or use to the property converted, or the controlling 4684. Compare the combined losses to your long-term gains interest in a corporation owning such property, at a cost that from casualties and thefts of business, rental, or equals or exceeds the amount you received as compensa- royalty-producing property. If the combined losses are the tion. For the condemnation of real property, such as standing same as or less than the gains, net the combined losses timber, the replacement period ends 3 years after the close of against your gains. Then enter the net gain on Form 4797. the first tax year in which any portion of the gain from the conversion is realized. The replacement period is 2 years for If your combined losses are more than the gains, your property other than real property. The replacement period for long-term gains and losses are treated as ordinary gains and both real and personal property is always 2 years from losses. Merge your long-term losses with your long-term involuntary conversions other than condemnations. Note, gains. however, that under State law standing timber may not be classified as real property under all circumstances. Reporting Gain or Loss From Income Producing Property— Your short-term losses from income producing (investment) If you elect to defer reporting the gain, you must file a property are reported on Schedule A of Form 1040. Gains statement with your tax return that the election is being made from short-term income producing property are added to your and include all the pertinent information concerning the gains from business, rental, and royalty-producing property to conversion and the replacement property. If you make the be offset against short-term losses from business, rental, and election, but do not spend all of your compensation, reim- royalty-producing property on Schedule E of Form 1040, and bursement, or proceeds on qualifying replacement property, are reported on Form 4797. Your total long-term loss on you must report the difference as income. income producing property is reported on Schedule A, Form 1040. Basis of replacement property—Your basis in replacement property is its cost minus any gain that you postpone. In this Condemnations—The way in which you include a taxable way, tax on the gain is deferred until you dispose of the gain or deductible loss from a condemnation in computing replacement property. your income depends on the kind of property involved, when you acquired it, how long you held it, and whether or not a Reporting Gains and Losses From Casualties, Thefts, part of your gain is due to depreciation. Do not include Condemnations, and Noncasuaity Losses condemnation gains in taxable income if you elect to defer tax on the gain by acquiring replacement property, as Gains and losses are reported differently for casualties and discussed above. thefts than they are for condemnations, and for noncasuaity business losses. Property Held for 1 Year or Less—You treat a gain or loss from property used in your business or held for the production Casualties and Thefts—You first use Form 4684, "Casual- of rents or royalties as ordinary gain or loss on Form 4797. ties and Thefts," to calculate and report casualty and theft You report a gain or loss from property you held for invest- losses and gains. Section B of Form 4684 is used for losses ment as a short-term capital gain or loss on Schedule D, and gains from business and income-producing property. Form 1040. Your losses and gains are reported according to how long the property was held and the purpose for which it was used- Business or Investment Property Held for More Than such as business, rental, to produce royalties, or for invest- 1 Vfear—If you held property for more than 1 year before it ment. You may also be required to file Schedules C, D, and F was condemned or sold under a threat of condemnation, you of Form T. must list the gain or loss on Form 4797, together with any other gains and losses from business property. Each item of property for which you are claiming a loss or gain must be listed separately. If more than four items were Property Held Primarily for Sale—You report a gain or loss involved in any one casualty or theft, attach additional copies from property you held primarily for sale to customers in the of the form. If you incurred losses or gains from more than one ordinary course of business as ordinary income or loss. You event you must use a separate Form 4684 for each event. use the appropriate business schedule, either Schedule C or Form 4684 summarizes your casualty and theft losses and F of Form 1040, regardless of how long the property was gains and directs you to the proper form for reporting each. held. You never report such transactions on Schedule D of Form 1040 or on Form 4797.

47 Property Held for Personal Use—You report the gain from Waiter contacted all told him that because of the large property held for personal use as a short-term or long-term acreage of timber damaged that spring there was more gain on Schedule D of Form 1040. Under no circumstances timber available than could be absorbed by the market may you deduct a loss from the condemnation of property They suggested he contact them next spring^ that you held for personal use. Walter claimed as a loss his basis in the 1.200 cords of For more information, see 1RS Publication 334, "Tax Guide wood totally destroyed. The basis was determined as for Small Business," or 1RS Publication 549, "Non-business shown in Figure VII-1. Walter reported the loss on Disasters, Casualties and Thefts." Form 1040, Schedules D and F (Form T), Form 4684, and Form 4797. Noncasualty Losses—Losses to timber held for use in a trade or business, such as those described in Rev. Rul 87-59 On November 10, 199S, Walter was able to sell the stands and Rev. Rul. 90-61, page 94, are reported on Form 4797 to Identified for salvage. In 1994 the forester estimated that be netted against other gains and losses from disposals of these stands contained 2,t00 cords. The buyer, however, business property. estimated that the stands contained only 1,800 cords of merchantabie wood. The difference was due to the Example Vll^-S degradation over two summers since the hurricane. Waiter received $16,500 for the t.SOO cords. The allowable basis Comprehensive exempte: Walter Oreen own& $20 aares for this sate was determined as shown in Figure VII-2. The of timberland» which was affected by liufrican0 forco wind$ $1,233 loss should be reported as a noncasualty loss h on April 10,1994. Walter is a calendar-year taxpayer and 1995. The $9J 02 gain on the salvage sale ($16,500 - holds the timber lor u$e in a trade or busiti^ss^ activity. Ha $7,398) is reported on Schedule C of Form T If he elected maintains one timber account for ail of the stands. The to pay tax on the gain he would report it on Form 4797 as damage variad among the $tand$ of loblolly and $hortlaaf an involuntary conversbn. If Walter elected to postpone pine of various ages. Almost all of the trees in some stands paying tax on the gain by replanting the stands, or other- were uprooted and splintered so as to be unsaleable. wise acquiring qualifying replacement property, he would Some stands or parts thereof were subject only to file an attachment to his 1995 return detailing such things windthrow. Other stands or parts thereof suffered little as alt facts relating to the hurricane, the amount realized on damage. the sale, his computation of the gain, any gain to be reported, and the type and cost of replacement proper^v Walter tdentifiad the stands that were undamaged and acquired, ft the replacement property would be acquired instructed his consulting forester to cruise all the other after the time for filing the return, Walter should indicate m stands to determine the extent of the damage. He used the the statement that he intends to acquire replacement cruise data and on-the-^round inspections to determine the property within the required time period. In the subsequent stands that needed to be treated by a salvage cut. These year of acquiring replacement property» a statement should stands were put up for safe in July^ but by Decem-ber 31, be attached to the return giving detailed information on the 1994, no offers had been received. The timber buyers replacement property.

48 Figure VII-1—Schedule F (Form T)

Capita 1 Returnable Through Depletion

Line number on Quantity in MBF Jog Cost or other basis FormT scale , cords, or other unit (2) (1)

28. Estimated 5,000 cords $22.300 quantity...[at end of 1993] 30a. Addition for growth 220 (1 year) 33. Total at end of year, 5,220 22.300 before depletion 34. Unit rate 4.27 39. Quantity of timber lost 1,200 by fire or other cause during year 40. Allowable basis of loss 5.124 42. Net quantity and value 4,020 17,176 at end of year

Figure VII-2—Schedule F (Form T)

Capital Returnable Through 1 Depletion

Line number on Quantity in MBF. log Cost or other basis FormT scale, cords, or other unit (2) (1)

28. Estimated quantity 4,020 cords $17.176 [at end of 1994] 30a. Addition for growth 160 (1 year) 33. Total at end of year, 4.180 17,176 before depletion 34. Unit rate 4.11 37. Quantity sold 1,800 38. Allowable as basis of sale 7,398 39. Quantity of timber lost 300

by fire or other cause during year 40. Allowable basis of loss 1,233 42. Net quantity and value 2,080 8.545 at end of year

49 Chapter VIII. Tax Implications of Forest Stewardship

Introduction U.S. Dept. of Agriculture, Forest Service, Southern Forest Experiment Station, New Orleans, Louisiana). One such Most timber owners get many benefits from owning forest opportunity, conservation easements, is discussed here land. You may have a special interest in providing wildlife because of its potential to significantly increase long-term habitat, conserving soil and water, protecting endangered stewardship. plants and animals, or other activities that may not be related to the production of income, except by increasing the market Conservation Easements value of the property should you sell it. Forest stewardship simply refers to the care of forest land in the best sense of If you are highly motivated to engage in activities that conservation and wise use. Tax law may be of benefit in improve the ecological value of forest land, it may be in your these efforts. You need to be aware, however, that the current best interest to sell, donate, or othenwise transfer all or part of tax laws may not support all your efforts. This chapter your ownership interest in the property to an organization discusses the tax incentives for wise stewardship of forest specializing in the management of forest and other lands for land. conservation purposes. The possibilities are not limited to the outright transfer of all ownership interests. You can legally Tax Law Keyed to Production of Income transfer less than your entire interest in your forest land. For example, you can transfer a restriction on the use of the Tax law is keyed to the production of income. Expenses property for purposes other than forest land, such as housing, incurred for an activity carried out to produce income as commercial, or industrial development. You could transfer this either a trade or business, or investment can generally be restriction and retain the right to live on and produce timber recovered as discussed in Chapter V. A critical factor is that on the property. Such transfers are a way for you to control the expense incurred for an activity be directly related to its the use of the land during and after your lifetime. By selling potential to produce income. Even though you may expect to such a restriction, you would get some income from the sell timber sometime during your life, timber production may development rights, or by donating the restriction (in perpetu- not be the primary factor motivating your activities. ity) to a qualifying organization, you may qualify for a chari- table deduction on your income tax return. You may have a special interest in wildlife and manage your forest land to attract certain species. In some regions of the For additional information on this topic, you may want to country wildlife activities, such as planting food plots and consult Preserving Family Lands by Stephen J. Small, P.O. shrubs for food and cover, and maintaining a timber species Box 2242, Boston, MA 02107. and stocking mix to favor certain species, may be related to the production of income by leasing your land for hunting. In Qualifications for Charitable Deduction of Conservation other cases expenditures for these activities may be made Easement—Under some circumstances, a donation of a strictly to increase your enjoyment of the property. To restriction on the development of your forest land may qualify expense your management costs for tax purposes, you'll as a charitable contribution. The criteria necessary to qualify need to manage your property so that your activities do not for a charitable deduction need to be carefully evaluated. You bring into question your intention to eventually make a profit should seek legal counsel to facilitate the process. Three from the property, as discussed on page 27. basic criteria must be considered.

In many cases it is possible to carry out wildlife habitat Qualified organization—Your contribution must be made to management activities as part of your timber management one of the following qualified organizations: program, and receive income from both activities. Your (1) A unit of local. State, or U.S. government, wildlife management expenses may be incidental to your (2) A publicly supported charitable, religious, scientific, timber management activities. In such cases the expenses educational, etc., organization, or could be treated as timber management expenses. If, (3) An organization that is controlled by, and operated for the however, wildlife management activities dominate your exclusive benefit of, a governmental unit or a publicly management program and you don't receive any income supported charity. related to wildlife, the expenses may not qualify as ordinary and necessary business or investment expenses. In some Conservation purpose—Your contribution must be made only cases the expenses might qualify to be added to the basis of for one of the following purposes: your property, as discussed on page 27. (1 ) Preservation of land areas for outdoor recreation by, or for the education of, the general public. Many of the best opportunities to promote stewardship with (2) Protection of a relatively natural habitat for fish, wildlife, your forest land are associated with forest estate planning. or plants, or a similar ecosystem. This topic is the focus of a companion publication. Estate (3) Preservation of open space, including farmland and Planning for Forest Landowners: What will become of your forest land. The preservation must yield a significant timberland? (General Technical Report SO-97, Sept. 1993, public benefit. It must be either for the scenic enjoyment

51 of the general public, or under a clearly defined Federal, Because of the need for accuracy a professional appraisal State, or local governmental conservation policy. should be used to determine the value of your donation. If (4) Preservation of a historically important land area or a you claim a deduction for donated property of more than certified historic structure. $5,000, in addition to filing the information required on claimed deductions of over $500. you must get a qualified Qualified real property ir)terest—At)y of the following interests written appraisal made by a qualified appraiser, and you must in real property qualify. Forest land and associated timber are attach an appraisal summary to your tax return. The amount real property. of deduction you claim may be subject to other restrictions, as (1 ) Your entire interest in real estate other than a mineral discussed in 1RS Publication 526. Charitable Contributtons. interest. (2) A remainder interest, that is the interest after an interest you hold for some designated time period or a time period fixed by an identifiable event, such as your death. (3) A restriction on how the property may be used if the restriction is perpetual.

Valuation of Donation—^The value of a donation of a conservation easement generally is equal to the value of the entire property before the donation minus its value after the donation. The best evidence of this difference in value often is sales of similar properties in the area that were bought and sold, some without any restrictions, and some with restric- tions similar to those you're considering for your property. The basic principle is demonstrated in Example VIII-1.

Example VlfM

Value of Donated Conservation Easement: You own 300 acres of forest îand, Simïïar land in the area has a fair market value of $1^aQ per acre. However, land in the gênerai area that is restricted solely to forestry uses consistent with the county's open-space program has a FMV Of $600 p0f ^r0. Your cour>ly wants to preserve green space in the area of your property and prevent further dev0lopm0rtt. The county is most înt^restod in preserving the 200 of your acres which are visible from a major h]ghway>

You grant the county an enforceable opeo space easement in perpetuity on the 200 visible acres, restricting its use to selective timber harvesting consistent with the open-space easement. Tha Value of the easement is

FMV of the property before granting easam^nf : $1,200 X 300 acres $360,000

FMV of the property after granting easement: $1,200 X100 areas $i2o,ooo $600 X 200 acres m.m ,„2,40.00P, Value of easement S120.000

52 Chapter IX. Other Tax Considerations

Installment Sales is received is calculated using the gross profit percentage. If recapture applies because of amortization of reforestation Introduction expenditures or exclusion of cost-sharing payments from gross income, some of the gain will be reportable as ordinary It may be to your advantage to receive at least one payment income. from the sale of timber after the tax year in which the disposi- tion occurs. Such sales are referred to as installment or Gross Profit Percentage—The percentage of a payment deferred payment sales. The installment sale provisions apply that is gain usually remains the same for each payment. In automatically whenever at least one payment is received in a the absence of any recapture, this percentage is determined tax year after the tax year of the sale. An installment sale is by dividing the gross gain from the sale by the contract price, the only way to spread the tax burden from a lump sum as explained on Form 6252. The method of calculating gross timber sale over more than one tax year. The installment sale profit percentage is shown in Example IX-1. provisions may also be beneficial if you sell your forest land. If your activities are subject to the passive activity loss rules Example JX-i and you have a loss, special rules will apply, as discussed on page 28. Calculating gross profit percentage: You sett timber at a contract price of $10,000, and your allowable basis in tfte The receipt of payments in more than one tax year could timber sold is $2,000, Your cost to sell the timber was arise from either a lump-sum sale or a "pay-as-cut" contract. $500. The total gain on the sale is $7.500 ($10,000 - $500 - Atypical lump-sum sales contract might require an initial $2.000) and your gross profit percentage is 75 percent down payment, a minimum annual payment, and payment in ($7,500 + $10,000). After subtracting out interest, full before timber cutting starts. A typical pay-as-cut contract 75 percent of each payment, íncludír^g the down payment» might require an initial down payment and monthly payments is reportable as your gain from the sale in the tax year fn based on the volume cut and scaled during the previous which you receive the payment. month. If a pay-as-cut contract qualifies for treatment under Section 631 (b), the contract is not treated as an installment Selling price—The selling price is the entire cost of the timber contract and the Section 631 (b) rules apply as discussed in to the buyer. It includes any money and the fair market value Chapter VI. of any property you are to receive from the buyer. It also includes any debt associated with the property sold for which There are limitations on the use of the installment sale the buyer takes the property subject to, pays, or assumes. method. The method does not apply to dispositions of real The debt could be a note, mortgage, or any other liability, property held for sale to customers, but an exception allows such as a lien, accrued interest, or taxes you owe on the this method to apply to the disposition of timber by taxpayers timber. If the buyer pays any of your selling expenses for you. whose timber ownership qualifies as a farm business under that amount is also included in the selling price. Section 2032A of the Internal Revenue Code. The installment sale provisions do not apply to rent received from a timber- Generally, if the selling price is reduced at a later date, the land lease. Nor do the provisions apply to sales resulting in a gross profit (gain) on the sale must be refigured. You calcu- loss. Losses must be reported in full in the year incurred. If a late a new gross profit percentage that applies to any transaction qualifies, the installment sale provisions apply remaining payments. The gain still to be reported is then automatically whenever at least one payment is received in a spread evenly over the remaining installments. You cannot go tax year after the tax year of the sale. back and refigure the gain you reported in earlier years.

Calculating Installment Sale Income Adjusted allowable basis—-The adjusted allowable basis for timber sold is the allowable basis determined by multiplying Each installment payment usually consists of three parts: the appropriate depletion unit by the number of units sold, (1 ) Return of your investment (basis) in the timber sold, explained more fully on page 31. From the selling price you (2) Gain on the sale, and subtract the selling expenses paid in connection with the sale (3) Stated or unstated interest and your adjusted allowable basis to determine the gain.

Any interest included in a payment is reported separately as Paymenfs—You must figure your gain on the payments you ordinary income. This is also the case for unstated (imputed) receive each year from an installment sale, including the interest, discussed later in this chapter. Expenses you incur down payment and each later payment of principal on the to sell timber are added to your allowable basis in the timber buyer's debt to you. The buyer's note (unless it is payable on sold, and the total is subtracted from the sale price. The demand) is not considered a payment on the sale. Its full face difference is the gain. The gain will be a capital gain if the value is included when figuring both selling price and contract timber you sold was a capital asset and was held for more price. The payments you receive on the note generally are than one year. The gain to be reported each year a payment reported on the installment method.

53 Escrow Accounts—In some cases, the sales agreement, or sale or exchange, and (2) there is total unstated (or inad- a later escrow agreement, may call for the buyer to establish equately stated) interest. The imputed interest rules do not an irrevocable escrow account out of which some or all of the apply if the sales price will not exceed $3,000.1RS Publica- remaining installment payments, including interest, are to be tion 537 provides information for determining imputed made. An escrow account is irrevocable if the buyer cannot interest. revoke the account and recall the funds to his own use. Generally, these sales may not be reported on the installment Reporting Installment Sales—Installment sales are method. The buyer's obligation is paid in full when the reported on Form 6252. This form is used to report the balance of the purchase price is deposited into the escrow original sale in the year it takes place, and to report payments account. When the escrow account is established, you no received in later years. The sale also should be reported in longer rely on the buyer for the rest of the payments, but on the year it takes place on Form T, discussed on page 31. the escrow arrangement. Sales to Related Parties—if you make an installment sale of If an escrow arrangement imposes a substantial restriction on timber to a related party who then makes a second disposi- your right to receive the sale proceeds, the sale may be tion within 2 years of the first disposition, and before all reported on the installment method, provided it otherwise payments are made under the first disposition, a special rule qualifies. In order for an escrow arrangement to impose a may come into effect. Under this rule, part or all of the substantial restriction, it must serve a bona fide purpose of amount the related party realizes as a result of the second the buyer—that is, a real and definite restriction placed on the disposition is treated by you at the time of the second seller or a specific economic benefit conferred on the buyer. disposition as if you had received it from the first disposition. Because of the nature of most timber sale transactions, See 1RS Publication 537 for details. irrevocable escrow accounts will usually preclude installment reporting. Alternative Minimum Tax

Electing Out—You can choose not to have the installment The purpose of the alternative minimum tax (AMT) for sales rules apply to your sale. If you make this election, you individuals is to make certain that if your income tax liability is must report your entire gain from the sale on your return for reduced because of certain tax benefits, you will pay at least the year of sale, even though you will not be paid all of the a minimum amount of tax. selling price until later. The election is made by not reporting the sale on Form 6252. Instead, report it on Schedule D of Your potential liability for the alternative minimum tax de- Form 1040, or Form 4797 if the timber is used in a business. pends on the structure of your timber activities, your other This election does not apply to disposals under Sect- sources of income, and the deductions you claim. Timber ion 631 (b) because they are not treated as an installment income does not generate a tax preference subject to the sale. To figure the selling price under the election, you must AMT, nor does the depletion allowance for timber you cut. compute the buyer's installment obligation to you at its fair Timber sale income may, however, increase your total taxable market value. income sufficiently to indirectly trigger an alternative minimum tax liability. This would be the case if your income is in- Unstated Interest and Imputed Interest—If the note or creased above the exemption amounts specified for the other document of indebtedness you receive from the buyer alternative minimum tax and you have realized certain tax provides for no interest on the deferred payments or provides benefits related to all of your activities. for inadequate interest as defined in 1RS regulations, you are required to impute interest. Imputed interest is reported in the The deduction of your timber management expenses may same manner as stated interest by the seller. Likewise, the also trigger an alternative minimum tax liability. This is the buyer must treat imputed interest in the same manner as the case if you recover your expenses as miscellaneous itemized payment of stated interest. deductions on Schedule A, Form 1040, discussed in more detail on page 30. Also, if you are not materially participating Generally, a document of indebtedness provides for adequate in the conduct of your timber activity, as discussed on stated interest if it calls for interest at a rate no lower than the page 29, any passive loss generated by your timber activity test rate of interest. For seller financing of less than may trigger an alternative minimum tax liability. For additional $3,332,400 the test rate of interest is the lower of the information see 1RS Publication 909 "Alternative Minimum applicable Federal rate of interest or 9 percent compounded Tax for Individuals." semiannually. Each month, the 1RS issues tables giving three sets of the applicable Federal rate. The tables applicable to The alternative minimum tax is determined by completing your sale can be obtained by calling the IRS's toll free Form 6251. A worksheet in your tax booklet is used to taxpayer assistance number. determine whether or not you need to file Form 6251. However, you are required to complete and file it if you, Imputed interest rules may apply to any document of indebt- among other things, had during the tax year (1 ) accelerated edness issued for the sale or exchange of your property if depreciation in excess of straight line, (2) income or loss from some or all of the payments scheduled under the debt tax shelter farm activities. (3) income or loss from passive instrument are due more than 6 months after the date of the activities, or (4) investment interest expense. See IRS sale or exchange under a contract which: (1) some or all of Publication 909 for a complete list. Note that all references to the payments are due more than 1 year after the date of the

54 depletion in Publication 909 refer to percentage depletion, not transactions are infrequent and you are primarily engaged in to cost depletion applicable to timber. some other business, trade, or profession. For example, a farmer whose property includes a tract of timber or a person The alternative minimum tax is calculated by first determining employed in the city and owning woodland outside the city, your alternative minimum taxable income, defined as the sum who occasionally cuts timber for firewood and sells it, may be of (1) the taxable income as determined on your Form 1040: liable for self-employment tax on the income received. (2) any regular tax net operating loss deduction claimed; and (3) adjustments pertaining to the standard deduction, medical Treatment of Spouses and dental expenses, miscellaneous itemized deductions, taxes, certain interest, depreciation, tax shelter farm loss, and If you are the sole proprietor of a trade or business and your passive activity loss, among others. To this sum you also add spouse works for you, he or she may be your employee. The your alternative minimum tax items relating to accelerated treatment of employees for employment tax purposes is depreciation on real property placed in service before 1987; explained on page 56. Alternatively, both you and your accelerated depreciation on leased personal property placed spouse may be engaged in a trade or business. In that case, in service before 1987; incentive stock options; tax exempt each individual's net earnings from self-employment are interest on certain private activity bonds; and percentage subject to self-employment tax. If, however, you and your depletion (this does not apply to timber) among others (see spouse join together in the conduct of a business and share 1RS Publication 909 "Alternative Minimum Tax"). The final in its profits and losses, a partnership may have been step is to subtract from this total your alternative tax net created. If so, you and your spouse should report the operating loss deduction. business income on a partnership return. Form 1065. Attach Schedules K-1 to Form 1065 to show each partner's share of Alternative Minimum Tax Calculation the net income, and file separate Schedules SE (Form 1040) to report self-employment tax. (1) Subtract your exemption amount from your AMT taxable income. Your exempt amount in 1994 was $45,000 if married Excluded Income Items filing jointly, $33,750 if single or head of household, and $22,500 if married filing separately. (2) Multiply the balance The following timber-related items are not included in by 26% on the first $175,000 ($87,500 if married filing computing net earnings from self-employment: separately), and 28% on any amount in excess of the first (1) Rental payments received for the use of real estate and $175,000 ($87,500 if married filing separately). Add these two personal property leased with real estate if you are not a amounts to get your tentative minimum tax. The AMT is the real estate dealer and you do not provide substantial difference between this tentative tax and your regular tax. services in the rental activity. (2) Gains that qualify for capital gains treatment. Gains from Self-employment, Social Security Tax the sale or other disposal of standing timber generally qualify for capital gains treatment if the timber is not held You may owe self-employment tax if you are engaged in a primarily for sale to customers in the ordinary course of a timber trade or business as a sole proprietor, independent trade or business in which you are engaged or you contractor, or member of a partnership or member of a limited dispose of it under the provisions of Section 631 (b), as liability company. This tax is used to provide social security discussed on page 36. If you cut the timber yourself or and Medicare coverage to self-employed taxpayers. The tax have a contract logger cut it for you, and elect to treat the is imposed on net earnings from self-employment, which cutting as a sale under the provisions of Section 631 (a), includes earnings derived by an individual from a trade or as discussed on page 38, the gain determined under business, less all business deductions allowed for income tax Section 631 (a) would not be included in net income from purposes. You must pay self-employment tax if you have net self-employment. Your profit on the sale of the logs or earnings from self-employ ment of $400 or more. The self- manufactured products, however, may be subject to the employment tax is composed of two parts. The tax rate is self-employment tax. 15.3% (12.4% social security tax plus 2.9% Medicare tax). Net earnings from self-employment up to $61,200 for 1995 Christmas Tree Growers are subject to the social security portion of the tax. If you also earn wages as an employee in 1995 that are subject to social Growers of Christmas trees are subject to the rules appli- security tax. only the first $61,200 of your combined wages cable to timber producers in general. The self-employment and net earnings from self-employment are subject to social tax applies to ordinary income received from the sale of trees. security tax. All net earnings from self-employment are Gains from the sale of Christmas trees may qualify as capital subject to the Medicare portion of the self-employment tax. gains, as discussed on page 59, and therefore not be subject You are not exempt from self-employment tax if you are to the self-employment tax. receiving social security benefits, are fully insured under social security, or are not othen/vise required to file an income Forest Products tax return. Nor are you exempt on account of age. The sale of forest products other than standing timber, and a If income from your timber operations is considered as cutting not under a Section 631(a) election, usually produce received in the course of a trade or business, it may be ordinary income. Receipts from these sources are therefore subject to the self-employment tax even though your timber included in self-employment income.

55 Cost-Share Payments would be reported on Schedule SE of Form 1040. Remem- ber, however, that if the Section 631(a) election has been Net payments received under the Agricultural Conservation made in prior years, you may not forgo the election in any Program (ACP), the Forestry Incentives Program (FIP) and following year without permission of the 1RS. There is a one- Stewardship Incentive Program (SIP), as well as those time exception to this rule, however, as discussed on received under State cost-share programs, are included in page 40. self-employment income if your activity is considered a business, unless specifically excluded from reportable If you dispose of standing timber held primarily for sale to income for Federal income tax purposes. All or some portion customers in the ordinary course of a trade or business, the of such program payments may qualify for such exclusion gain will be ordinary income subject to the self-employment under rules discussed on page 40. Only the portion actually tax. unless you dispose of it in such a way that the provisions excluded from taxable income may be excluded from of Section 631(b), discussed on page 36, apply. self-employment income. If your timber is not held primarily for sale and you sell it "on Net Conservation Reserve Program (CRP) payments (both the stump" (lump-sum sale), the gain usually is a capital gain cost-share and rental) are also generally included in and is not subject to the self-employment tax. self-employment income. CRP cost-share payments do not currently qualify for income tax exclusion under the rules For more information on the self-employment tax. see 1RS discussed on page 40. However, if the payments are treated Publication 533, "Self-Employment Tax." If you are a farmer, as a conservation expense under Section 175 of the Code, refer to Publication 225, "Farmer's Tax Guide." as discussed on page 24, they become a deduction in determining net earnings from self-employment. Employment Status

How to Calculate Self-Employnfient Tax If you hire an individual to perform work on your forest property, that person may be your employee. As an employer, The self-employment tax is calculated by completing Sched- you will have several tax responsibilities. Most employers ule SE of Form 1040, "Computation of Social Security must withhold, deposit, report, and pay the following employ- Self-Employment Tax." If you work as an employee and earn ment taxes: wages or salary subject to withholding that equal or exceed • Income tax withheld from employee's wages. the maximum amount subject to the social security portion of • Social Security and Medicare taxes (employer and the social security tax, and also have income from a trade or employee portion). business, you do not pay self-employment tax on your • Federal unemployment tax (FUTA). FUTA tax is not earnings from the trade or business. However, if you earn withheld. wages subject to withholding that total less than the maxi- mum amount, and also have income from timber operations An 1RS Form W-2, which shows wages paid and taxes subject to the self-employment tax, the net income from withheld during the year, must be prepared at the end of each timber operations will be taxed to the extent of the difference year. Copies are sent to the Social Security Administration between your wages and the maximum. In addition, all and to the employee. Internal Revenue Service Publica- self-employment income is subject to the Medicare tax. tion 15, Circular E, Employer's Tax Guide, provides informa- tion concerning an employer's tax responsibilities. You should Including Timber Gains In Self-Employment Income To check with your State concerning any State income and Guarantee Benefits unemployment tax requirements.

Qualification for social security benefits for you or your An individual is an employee, for Federal employment tax dependents depends in part on how much social security purposes, if he or she has the status of an employee under and/or self-employment tax you have paid. In 1995, you the common law rules applicable in determining an employer- receive a quarter of social security credit for each $620 of employee relationship. Generally, the relationship of employer income earned during the year that is subject to the social and employee exists when the person for whom the services security tax. If you are not certain that you will qualify for full are being performed has the right to control and direct the benefits on retirement, you should check on your status by individual who performs the services, not only as to the result contacting the Social Security Administration Office listed in to be accomplished by the work—but also as to the details your phone book under "United States Government, Social and means by which that result is met. That is. an employee Security Administration." is subject to the will and control of the employer not only as to what shall be done, but also as to how it shall be done. It is If you need to make additional contributions you may prefer not necessary that the employer actually direct or control the not to make an election under Section 631 (a) to treat the manner in which services are performed, it is sufficient if the cutting of timber as a sale. If you are a farmer who cuts and employer has the right to do so. Independent contractors are sells timber, you may, for the sake of obtaining benefits, not subject to this right of control and direction. decide not to make the election. If so, include your timber income and expenses, and the basis of the timber sold, as If the tests for defining an employee are met, it doesn't matter farm income and expenses on Schedule F of Form 1040. that the person is designated as anything other than an Such income would be subject to self-employment tax and employee—or how the payments are measured or paid or

56 what they are called. Thus, it is irrelevant that an employee is report, the greater is the control of those supervising him called an independent contractor, partner, or agent. (her), indicating employment. 12. Payment by time, not job. Independent contractors are The Internal Revenue Service has developed a 20-factor test more often paid by the job. to use as a guide in determining whether a worker is an 13. Payment of traveling expenses. An employer generally employee or an independent contractor. These factors can retains the right to regulate the employee's business help ascertain whether sufficient control is present to estab- activities. lish an employer-employee relationship. The twenty factors 14. Furnishing of tools. Independent contractors more often should be used with caution. The degree of importance of furnish their own tools and materials. each factor varies depending on occupation and the factual 15. Investments. Independent contractors more often invest context in which services are performed. They are: in facilities that are used in peforming services. 1. Instructions. The right to give instructions is relevant, not 16. Realization of profit or loss. A worker who can realize a whether they are actually given. profit or loss in addition to that ordinarily realized by an 2. Training. If the worker is required to receive training to employee from his services is generally an independent learn how to do the work, an employment relationship is contractor. likely. 17. Working for more than one person at a time. An indepen- 3. Integration. The more the worker is integrated into the dent contractor will often perform services for more than business operations, the more likely he (she) is an one business at a time. employee. 18. Making services available to the public. This indicates the 4. Services rendered personally. This tends to indicate an status of an independent contractor. employment relationship when required. 19. Right to discharge. An independent contractor cannot be 5. Hiring, supervising, and paying assistants. If the worker is fired as long as he (she) produces a result that meets responsible for his assistants, this is indicative of inde- contract specifications. pendent contractor status. 20. Right to terminate. If the worker can terminate services 6. Continuing relationships. A continuing or recurring nature without liability, this indicates an employment relationship. of work suggests employment. 7. Set hours of work. If hours are established by the If you pay a worker for services rendered on your timberland business, this tends to indicate employment. and you are not sure whether the payee is an employee or 8. Full time required. An independent contractor has more not, you can obtain an 1RS ruling by filing Form SS-8. freedom as to when and for whom he (she) will work. 9. Doing work on business premises. If this is required, it If a worker is determined to be an independent contractor, suggests control by the employer. and you make payments to that person aggregating $600 or 10. Order of sequence set. The more this is controlled for, more in a calendar year, you must file an information return instead of by, the worker, the more that employment is (1RS Form 1099-MISC) reporting the total paid. This return suggested. must be filed with the 1RS by February 28 of the following 11. Oral or written reporting. The more the worker must year, with a copy to the payee by January 31.

57 Chapter X. Christmas Tree Production

General Considerations the Christmas tree farm. Only those who materially partici- pate in the business (see page 28) can deduct current Most Christmas tree producers are subject to the same expenses against non-Christmas tree income, unless the Federal income tax provisions, as discussed elsewhere in other income is passive in nature. The 1RS has specifically this handbook, as are timber owners in general. Neverthe- ruled that shearing and basal pruning costs are deductible less, there are several important distinctions. business expenses (see summary of Rev. Rul. 71-228, page 91). Christmas tree growing, because of the nature of the activity, usually constitutes a business rather than an investment. Uniform Capitalization Rules Therefore, Section 631 of the Internal Revenue Code is particularly relevant. Both Section 631 and the regulations Producers of Christmas trees that are 6 or fewer years of age relating thereto (discussed and explained in Chapter VI) when sold or cut are subject to the uniform capitalization provide that the term 'limber" includes evergreen trees more rules with respect to operating costs and carrying charges. than 6 years old at the time they are severed from their roots These rules require that preproductive costs must be and sold for ornamental purposes. This definition includes capitalized if the preproduction period of a crop is more than Christmas trees. 2 years. The law, however, permits certain farmers to elect not to have the uniform capitalization rules apply. If the It is possible that a person who sells standing Christmas election is made, (1) any gain on the sale of the crop is trees on an occasional basis could be considered as not recaptured as ordinary income to the extent of the deductions being in a business, but only an investor. In that case, the permitted by the election, and (2) you must use the alterna- rules for investors versus those for a business, as discussed tive depreciation system (straight line method) for all assets elsewhere in this handbook, would apply. placed in service in any year for which the election is in effect.

Establishment Costs Timber Sale Income

The general rule with respect to establishment costs, as Income realized from the sale or cutting of Christmas trees is discussed in Chapter V, is that all such costs—including subject to the same rules as for other types of timber. Both replanting—are capital expenditures and must be capitalized. Sections 631(a) and 631(b) apply (see Chapter VI). There This applies to Christmas trees, just as it does to other are, however, some unique aspects of application that must timber, whether you use the cash or accrual method of be considered. accounting. The only exception is that Christmas trees do not qualify for the reforestation amortization and tax credit, as Section 1221 noted earlier. All capitalized costs associated with Christmas As mentioned above, it is theoretically possible for an trees, therefore, are recovered by deducting them at the time occasional producer of Christmas trees who sells the of cutting or sale if not recovered earlier through involuntary standing trees on a lump-sum basis to qualify for capital conversion. gains treatment as an investor under Section 1221 (see page 36). In most situations, however, growers will be What if you plant trees with the intention of growing them for considered to be in a business. Therefore, you should not rely commercial timber production, take advantage of the refores- on Section 1221 if you wish to report sale proceeds as capital tation tax incentives, and then later sell the trees as Christ- gains. mas trees? You may be required to support your position if challenged by the 1RS. In any event, if the trees were Section 631(b) han^ested or sold within 10 years, the amortization deduction If capital gains treatment is desired, you should use the would be subject to the amortization recapture rules (see provisions of Section 631 (b) for sales of standing trees. In page 24). If harvested or sold within 5 full years, the credit most such cases, the unit of measurement would be either recapture rules would apply (see page 25). the individual tree or expressed in terms of linear feet. The same rules and procedures apply for Christmas trees as for Operating Expenses and Carrying Charges other timber (see Chapter VI).

The rules for deducting timber-related operating expenses Section 631(a) and carrying charges, as set out in Chapter V, apply as well Section 631(a) will apply to most producers—particularly to Christmas tree production if the trees in question are more those who sell cut trees on the wholesale market. It is than 6 years old when cut or sold. Since Christmas tree immaterial whether you cut the trees yourself or hire them growing is almost always a business, the favorable rules for cut. Reporting the cutting of Christmas trees as a sale under deducting business costs are applicable in such cases. Section 631 (a) is done in exactly the same way as for other However, the passive loss rules (see Chapter V) are also types of timber, as discussed in Chapter VI. Thus, the fair applicable to you or anyone else with an ownership interest in market value of the trees before they are cut should be

59 determined as of the first day of the tax year for the purpose Partnership Considerations—Tv^o or more growers should be of determining the Section 631 (a) gain. careful if they enter into an agreement to grow Chrlstnrias trees and harvest the trees themselves. If this results in a Making tlie Eiection—A Section 631 (a) election (see partnership for tax purposes, a partnership return must be page 38) generally can be made for any year. It does not filed and the Section 631 (a) election must be made on the have to be made for the first year of eligibility. Making the partnership return. An election on the individual returns of the election does not limit your options. For example, you may partners is not a valid election, cut Christmas trees under a Section 631 (a) election and also dispose of standing Christmas trees under a Section 631 (b)- Determination of Fair Marl

Example X-1

Capital gains on Ohr!$tma$ m^ operations: You are a calendar-yoar taxpayer, and you estabîîshod 5 Christmas tree plantations in S successive years, each comprising 10 acres and each containing 12,000 trees of fast growing pine Species. Two-year-old nursery stock was used» so the trees in the first plantatton are now above the minimum age {more than 6 years) required to qualify as timber under Section 631 (a) of the Internal Revenue Code,

You spent $1,210 to establish the first plantation, Later, you incurred $1,060 in capital costs, representing (a) certain carrying charges you had elected to capitalize; and {b) the cost of replanting lost trees. The adjusted basis just before the first cutting in November of that year thus amounted to $2,270. An inventory showed that there were now 11,000 weil'^ formed trees present. Of these, 6,000 were of sizes to be cut this year and 5,000 were to be left for further growth. A depletion unit ol $0^1 per tree was derived by dividing the $2,270 adjusted basis by 11,000 trees.

You cut the 6.000 salable trees yourself and delivered them to a wholesaler. You received $4.30 per tree from the whole- saler. The total cost to you for cutting and delivering the trees was $1,800. You elect on your tax return to treat the cutting of the trees as a sate under Section 63i (a) of the Internal Revenue Code.

The value on January 1 can be estimated by discounting the value when cut for 10 months as follows. Assume the trees were worth $3,60 each on November 1 when cut and that the applicable local interest rate is 10 percent.

Value £3.60 (1.0+ (i^12))^^ = (1 -f' 0.10/12)^^ - $3.31

You determine your taxable gain as follows:

6,000 trees cut with an estimated faîr market value of $3,31 per tree as of January 1 $19.860 Less; Basis for gain or loss at $0.21 per tree (.1,2gQ) Gain on timber {taxed as Section 1231 gain) $18,600 Gmn on sate of freest 6,000 trees sold for $4.30 per tree $25,800

Depletion allowance (Jan. 1 fair market value Of $3.31 per tree) $19.860 Cost of cutting and delivery 1 rSOO (g,1,g6p), Gain from harvesting and delivering (taxed as ordinary income) $ 4,140

60 Choose and Cut Operations—TyplcaWy, "choose and cut" Example X-2 Christmas tree sales do not qualify for capital gains treatment under Section 631(b)—see summary of Rev. Rul. 77-229, If ymi h^ not hArv^ted the trees bul iiâd entered ínta a page 92. In this type of operation, the grower usually provides Cööing contract wrth a jobber, you wotád oaîculate the gain a saw to the customer who proceeds to choose and cut a tree. The customer then pays a previously agreed upon price and takes the tree. Under these circumstances, buyers do not 6,000 tmeè sold tor $3.€0 per tree $21,600 have a contract-right-to-cut the tree as required under less: Section 631 (b)—they may choose not to cut and purchase a Baste tor gain or los$ al $0>21 pBt tree tree at all, at their option. Although it may be possible for you Expenses for administering cutftig to establish sales procedures to meet the Section 631 (b) oo^ract $1.260 requirements, the process would probably not be worth the Income 120 ihm) trouble. $20,2ao Section 631 (a) may be used for most "choose and cut" If the cutting coniract qualified as a dîspo$al with an operations, however. The 1RS position is that such sales are eüönomio interest retained under the provisibns of Seo of "cut timber" because the buyer never acquires title to or a tioo 631 (k>}, the $20,220 would be reported a$ a Section contract right to cut any tree. The buyer, in effect, acts as the 1231 gain. Othewise, thte amount wotitd be reported as agent of the grower in cutting the tree and purchases a cut ordinary income. Christmas tree.

61 Chapter XI. Form of Timberland Ownership and Business Organization

The form of ownership in which you hold your woodland Tenancy by the entirety—In some States, tenancy by the property is important from a tax standpoint. Further, if your entirety can be created between husband and wife with many timberland is structured as a business, the type of business of the features of joint tenancy. However, unlike joint tenancy, organization chosen also has significant tax implications. tenancies by the entirety are generally not severable by Additionally, non-tax factors bear on choosing an ownership action of one of the co-owners. They can normally only be and/or business format. These include your forest manage- created for real estate. ment goals, size of the property, family considerations, and income needs, among others. In the final analysis, the Life Estates decision should be based on the facts and circumstances of each personal situation. A life estate is a limited property interest. Title to the property is transferred, but the transferor or other designated person Basic Ownership Considerations (the life tenant) retains for a specified period of time the right to use, enjoy, and receive income from the property trans- Sole Ownership ferred. In addition to rights, however, a life tenant also has responsibilities. These include paying mortgage interest and Ownership of property in one name is normally the simplest property taxes, and keeping the property in good condition type of ownership. Transfers to others can usually be done and protecting it. with a minimum of red tape. Sole ownership typically affords the most complete control possible. In a business, sole Community Property ownership means an unincorporated business owned by a single individual (sole proprietor). A significant advantage is There are nine community property States—Arizona, that profit or loss from the business can be calculated California, Idaho, Louisiana, Nevada, New Mexico, Texas, separately from the owner's other sources of income. An Washington, and Wisconsin. In these States, as a general individual whose timberland is structured as a business rule, all property acquired during marriage by either spouse— reports most income and all expenses associated with the except by gift or inheritance—is community property (half forest property as a sole proprietor on either Schedule C or owned by each spouse). Schedule F of Form 1040. The net income or loss reflected on these forms is then transferred to the first page of Business Management Organization Form 1040 for inclusion in gross income. If your timberland acreage is small and you have only Co-ownership occasional transactions, you are most likely treating it as an investment for tax purposes. If your holdings involve continu- The undivided ownership of property by two or more persons ous transactions and generate fairly regular income, they is called co-ownership. This method of holding property is may constitute a business. If so, you should evaluate which often used as a substitute for more complex ownership or structure your business should have to best achieve your business arrangements. Transfer of an undivided co- objectives. A sole proprietorship, as discussed above, is the ownership interest at death can usually be done inexpen- simplest structure. If others are involved, you may want to sively and easily. There are disadvantages, however. form a partnership, incorporate, or consider the new limited Individuals often become involved in co-ownership without liability company form of organization. Tax considerations, realizing fully what it means in terms of loss of freedom and although important, are usually only one of the factors that control. Sales may be difficult to accomplish—one co-owner should be analyzed in determining type of organization. may want to sell, the other may not. Partnerships Tenancy in common—Each tenant in common can sell or divide his/her share and transfer his/her interest as he/she A partnership is generally defined as an association of two or wishes. Upon death of a tenant in common, that person's more persons to carry on, as co-owners, a business for profit. undivided interest passes to the heirs under State law or Legal tests for determining what is and what is not a partner- provisions of the will. ship have been developed in each State and vary from one State to another. Although usually an oral partnership Joint tenancy—^This arrangement is sometimes called joint agreement is valid, it is best to set out all details of the tenancy with right of survivorship. A joint tenant can sell or gift agreement in writing in orderte help avoid misunderstandings. his/her interest but cannot dispose of it by will. Upon the death of a joint tenant, that person's undivided interest Upon formation, no tax gains or losses are ordinarily recog- passes to the surviving joint tenants. This is a fragile device nized with respect to the transfer of assets to the partnership for property ownership. by the partners. The partnership takes the partners' basis (see page 17 for a discussion of basis) for property

63 transferred to it. The contributions of the partners to the problem since salaries qualify as a corporate business partnership need not be equal. Generally, assets brought into deduction. In addition, earnings can be accumulated at the the partnership, or purchased with partnership funds, become corporate level to a certain limit, which allows postponement partnership property. of taxes. The maximum corporate Federal income tax rate for ordinary income is also lower than the maximum Unlinnited liability—Except in the case of a limited partner- noncorporate rate. Corporate capital gains, however, may be ship (discussed below), each partner has unlimited liability for taxed as high as 35 percent in contrast to a 28-percent obligations of the partnership. Creditors must first go against maximum for noncorporate gains. Another major disadvan- the partnership assets; they can then proceed against the tage is that timber held by a corporation never receives a assets of the individual partners. stepped-up basis since corporate stock shares are inheritated at the death of a shareholder, not the underlying timber Minors as partners—Financial planning for partners in a assets. family timberland partnership often involves the transfer of partnership interests to minors—^to reduce the family income Subchapter S Corporations tax bill, to lower death taxes, or to involve older children in management of the woodland. Minors as partners, however, A Subchapter S corporation is a corporation formed in the may create problems. They are not legally competent to regular way under State law that has elected Subchapter S manage their property until they are of age. For Federal status by filing Form 2553 with the Internal Revenue Sen^ice. income tax purposes, a minor is not recognized as a partner The number of shareholders is limited to 35 and there are unless control is exercised by another person for the benefit numerous other requirements. of the minor, or the minor is competent to manage his or her own property under State law and to participate in partnership Tax considerations—With a Subchapter S corporation, there activities equally with adults. is no double taxation as with a normal corporation—that is, no Federal income tax at the corporate level. Corporate Partnership taxation—Although a partnership files an earnings, losses, deductions, capital gains, credits, etc., are income tax return, it is an information return only. Partner- passed through by means of a corporate information return to ships as entities do not pay taxes themselves. Income and the shareholders for inclusion on their individual income tax losses are passed through to each individual partner in returns. The shareholders use Schedule E of Form 1040 for proportion to his/her interest in the partnership and then this purpose. The procedure is the same as with a partner- entered on their individual returns. Schedule E of Form 1040 ship. One tax disadvantage of a Subchapter S corporation is is used for this purpose. that earnings cannot be accumulated at the corporate level to postpone taxation—they are taxed each year to the share- Limited Partnerships holders whether actually distributed or not. This is the same treatment as for a partnership. Also, as with a normal A limited partnership is one with one or more general corporation, timber never receives a stepped-up basis at the partners and one or more limited partners. In many cases, it death of a shareholder. can be an ideal arrangement for family-owned timberland. A limited partner is one who contributes cash or property but Limited Liability Companies not services. Limited partners are not personally liable for partnership debts. They are liable only up to the amount of A limited liability company (LLC) is a hybrid entity that can their investment in the partnership. Because of this status, combine the corporate benefit of limited liability for the they have no right of control over the business. A general owners with a partnership's tax advantage of pass-through partner also contributes cash or property but additionally has treatment for income tax purposes. The owners of an LLC are management rights. The income tax rules with respect to a termed "members" rather than shareholders or partners. limited partnership are generally the same as for a general There must generally be at least two members. For income partnership. tax purposes, an LLC may be classified as a partnership or a corporation, depending on State law requirements and the Corporations LLC's operating agreement.

A corporation is a separate legal entity that has most of the Income tax features—From an income tax perspective, an rights of an individual. It is owned by its shareholders and is LLC that is classified as a partnership compares favorably governed by a board of directors elected by the shareholders. with both Subchapter S corporations and partnerships, but A corporation's most notable feature is the limited liability has additional advantages not available with the other two. enjoyed by the shareholders. Legal actions against a Like a partnership, an LLC is usually permitted under State corporation are satisfied out of corporate assets—4he assets law to customize the distribution of both cash and property, of the shareholders are generally shielded from liability. and the allocation of both profits and losses, to its members. Also, neither the LLC nor the member recognizes any gain or Corporate taxation—A major tax disadvantage is that loss if the LLC distributes appreciated property to the earnings are taxed at the corporate level when earned and member. A Subchapter S corporation, on the other hand, again at the shareholder level when received as dividends. cannot customize distributions and recognizes gain to the However, paying earnings as salaries to shareholder- extent that the fair market value of any property distributed employees may eliminate some of the double taxation exceeds the corporation's basis in the property. An LLC

64 member can materially participate in the organization's passed through to the heirs or beneficiaries, a fiduciary business activities, so that income and losses passed income tax return must be filed by the executor of the estate through are considered active rather than passive, without or by the trustee of the trust. The current tax rate structure risking personal liability. In contrast, a limited partner who with its very low thresholds for the higher brackets, discour- materially participates in the partnership business within the ages retaining income under ordinary circumstances. The 28- meaning of the passive loss rules (see page 28) may risk , 31-, 36- and 39.6- percent tax rates begin at $1,500, $3,500, liability as a general partner for the partnership's obligations. $5,500. and $7,500, respectively.

Other Tax Entities

Estates and trusts represent a special case. They may or may not pay income tax as separate taxable entities. How- ever, if income is retained by either an estate or trust, and not

65 Chapter XII. Researching a Tax Question and Appeals Procedures

Very few sections of the Internal Revenue Code were written review, regulations are issued as proposed regulations and/or specifically for timber activities. We hope this publication will as temporary regulations. Temporary regulations have the answer most of your questions if you are a nonindustrial force of law and must be followed. Proposed regulations do private timber owner. This chapter introduces the steps not have the force of law. Proposed regulations become final involved In researching tax questions not adequately covered only after the public has had the opportunity to comment on in this handbook or 1RS publications. them and these comments are evaluated by the 1RS. The temporary regulations are superseded when final regulations If it Is necessary to research a specific Issue, several basic are issued. questions must be addressed. You must determine which section(s) of the Code (statutory law) apply, how these New regulations and amendments to existing regulations are sections are interpreted (regulations and revenue rulings) by issued as Treasury Decisions and published in the Federal the 1RS, and how these sections are interpreted (case law) by Registerand InternalRever)ue Bulletin. It would be impos- the courts. The final step is to determine how this total body sible to write regulations covering all possible circumstances. of law and interpretations applies to your factual situation. Thus, other types of rulings and forms of communication are also used in administering the Code. Statutory Law Revenue Rulings The Internal Revenue Code forms the foundation of Federal income tax law. The Code is promulgated by legislation Revenue rulings (Rev. Rul.), which are published in the Internal passed by the U.S. Congress. The U.S. Constitution requires Revenue Bulletin, are official interpretations by the 1RS of the all revenue bills to be initiated in the House of Representa- Code, related statutes, tax treaties, and regulations. They are tives. When a revenue bill is introduced by a member of the published for the information and guidance of taxpayers, 1RS House, the bill is referred to the House Committee on Ways personnel, and others. Generally, a revenue ruling sets forth and Means. If the committee recommends further action on the tax consequences of the transaction described in it. They the bill, public hearings are held. The Senate also considers may be used as authority in proceedings with the 1RS, but they the bill. The Senate Finance Committee may hold hearings. are not considered to be judicial authority. Differences between the House and Senate passed versions of the bills are reconciled in the Joint Conference Committee, General Counsel Memoranda which may also hold hearings. When the bill completes the legislative process and is signed by the President, it becomes General Counsel Memoranda (G.C.M.'s) are internal working part of the Internal Revenue Code of 1986, as amended. documents of the 1RS reflecting the opinion of its attorneys on a specific issue. G.C.M.'s reflect the logic behind the official The records of these hearings and committee reports provide position taken by the 1RS in an administrative pronouncement information on what the legislators hoped to accomplish by such as a revenue ruling. enacting the law. This "legislative intent" is important in interpreting the law when there is doubt about specific Revenue Procedures language included in the law. Revenue procedures, which are published in the Internal If you are unfamiliar with tax law it may be difficult to deter- Revenue Bulletin, are official statements of procedures mine which sections of the Code apply to a particular tax relating to sections of the Code, related statutes, tax treaties, question. Most topics are indexed according to tax issues and and regulations. Revenue procedures may set forth a use tax terms. The index in this publication is designed to procedure that affects the rights and duties of taxpayers or help you gain access to the law. Cross references from other members of the public and should be a matter of public commonly used terms are included. In addition, the appli- knowledge. In general, a revenue procedure tells the tax- cable Code sections are listed under the major headings. The payer how to do something (e.g., make an election relating to Smajor tax services listed on page 73 include comprehensive tax consequences). indexes that may also be used to determine the appropriate Code section. News Releases, Notices, and Announcements

Administrative Law Matters of immediate and general concern to taxpayers may be addressed in news releases that are provided to the The Commissioner of Internal Revenue is charged with media. Notices and announcements are published in the implementation of the Code. The first step is to write and Internal Revenue Bulletin and may be released first as news issue Treasury Regulations interpreting the Code and releases. Notices and announcements may be issued to specifying how it is to be implemented. These regulations inform taxpayers of recent changes in the law, or 1RS have the force and effect of law. However, the courts may intention to study a particular area of the tax law, or to clarify nullify regulations that are not consistent with the Code (and the tax consequences of a particular type of transaction. the intent of Congress). After drafting, internal study, and

67 Private Letter Rulings your tax home is located, or the U.S. Court of Federal Claims if you meet certain jurisdictional requirements discussed A private letter ruling is a written statement by the National below. These courts are independent judicial bodies and have Office of the 1RS that is issued in response to a taxpayer's no connection with the 1RS. request. It interprets and applies the tax laws to the taxpayer's specific set of facts. In effect, the taxpayer asks If you elect to bypass the 1RS appeals system, you may take the 1RS what the tax consequences will be if he or she takes your case to any of the above-mentioned courts. However, a a proposed action. Although letter rulings are made available case petitioned to the U.S. Tax Court will normally be to the public, you should not rely on a ruling issued to another considered for settlement by an appeals office in the 1RS taxpayer. Instructions for requesting a ruling appear in a region before the Tax Court hears the case. Where the revenue procedure that is updated annually. Under current taxpayer elects to bypass the IRS's appeals system, the Tax law, payment of a user fee is required for requests. Court may impose a penalty of up to $5.000 if it appears to the Tax Court that the taxpayer unreasonably failed to pursue Technical Advice Memoranda available administrative remedies. Generally, findings of these courts may be appealed to a higher court. The appeals A technical advice memorandum consists of advice or process is discussed under Audits and Appeals, page 69. The guidance furnished by the National Office of the 1RS upon following Federal courts hear tax cases. request of an 1RS District Office or Appeals Office. It re- sponds to a technical or procedural question on a specific set Tax Court—The Tax Court was created by Congress of facts arising out of an examination and involves the specifically to hear Federal tax cases. The court is an interpretation and proper application of tax law, tax treaties, independent court with its principal address in Washington, regulations, revenue rulings, or other precedents published DC, but hears cases throughout the Nation in designated by the National Office. Although these memoranda are made Federal courtrooms. The Tax Court has jurisdiction of a case available to the public, you should not rely on a technical only if the 1RS issues a statutory notice of deficiency. You advice memorandum with respect to another taxpayer. The have 90 days (150 days if mailed to you outside the United taxpayer may request that a District or Appeals Office refer an States) from the date the notice is mailed to file a petition with issue to the National Office for technical advice. Instructions the Tax Court. Generally, the Tax Court hears cases only if on requesting technical advice are published in a revenue the tax has not been assessed and paid; however, you may procedure that is updated annually. pay the tax after the notice of deficiency has been issued and still petition the Tax Court for review. If your case involves a Case Law dispute of not more than $10,000 for any one tax year or period, the Tax Court provides a simple alternative for If a question is clearly covered by the Code, you must follow resolving disputes. At your request, and with the approval of the Code or seek legislative remedy~4hat is, have the Code the Tax Court, your case may be handled under "the small tax changed. If your circumstances are covered by the regula- case procedures" whereby you can present your own case to tions or Revenue Rulings, then you must follow them or the Tax Court for a binding decision. If your case is handled expect that the 1RS will challenge any contrary position taken. under this procedure, the decision of the Tax Court is final If you disagree with the position taken by the 1RS in propos- and cannot be appealed. You can get more information ing adjustments to your tax, then you may appeal through the regarding the small tax case procedures and other Tax Court administrative appeals process and may have to defend your matters from the U.S. Tax Court, 400 Second Street, N.W., position in court. Sometimes your circumstances may not be Washington, DC 20217. specifically covered by the Code, regulations, rulings, court decisions, etc. In that case, you and your advisors must District Courts and Claims Court—Generally, District interpret the law yourselves, consistent with what you believe Courts and the Court of Federal Claims hear tax cases only to be Congressional intent, and seek justification for your after you have paid the tax and have filed a claim for a credit interpretation in the general body of tax literature. or refund with the 1RS. You may file a claim for a credit or refund if, after you pay your tax, you believe the tax is Case law consists of the findings of the various Federal incorrect. If your claim is rejected by the 1RS. you will receive courts on those tax questions brought to trial. The signifi- a notice of disallowance of the claim unless you signed a cance of the findings of a court on an income tax matter Form 2297, Waiver of Statutory Notification of Claim Disal- varies greatly, depending on the particular court involved and lowance. If the Service has not acted on your claim within the response of the 1RS to the findings of the court. 6 months from the date you filed it, you may then file suit for refund. You must file a suit for a credit or refund no later than The types of courts are reviewed first. Then the possible 2 years after the Service disallows your claim or a Form 2297 responses of the 1RS to court rulings are reviewed. Finally, is filed. guidelines on how to interpret court decisions are provided. You may file your suit for credit or refund in your United States Federal Court System District Court or in the United States Court of Federal Claims. However, the Court of Federal Claims does not have jurisdic- If you and the 1RS still disagree after your appeals confer- tion if your claim is for credit or refund of a penalty that relates ence within the 1RS. you may take your case to either the to promoting an abusive tax shelter or to aiding and abetting U.S. Tax Court, the U.S. District Court for the district in which the understatement of tax liability on someone else's return.

68 Circuit Courts of Appeals—The findings of either the Tax How Returns Are Selected for Examination Court or Federal District Courts can be appealed by either the taxpayer or the Government to the appropriate Circuit Court Your return may be examined to verify the correctness of of Appeals. Appeals from the Court of Federal Claims are income, exemptions, and credits. Most returns are selected heard by the Court of Appeals for the Federal Circuit. and given a score by a computer program called Discriminant Function System (DIF). The scores assigned by DIF relate to U.S. Suprenne Court—The findings of Circuit Courts of the probability that an entry is erroneous. Based upon these Appeals and the Court of Appeals for the Federal Circuit may scores, 1RS personnel screen and select returns for examina- be reviewed by the U.S. Supreme Court. The taxpayer or the tion. Periodically, returns are also selected under the Tax- Government may file a petition for a "writ of certiorari" payer Compliance Measurement Program (TCMP). This is a (request to be heard) with the Court. If the Justices agree to random selection system used to evaluate overall compliance hear the case, a writ of certiorari will be granted. Othen^/ise and provide the statistical base used to score returns under certiorari will be denied and the findings of the appeals court the DIF program. Returns may also be selected as part of a are binding on the parties. As a practical matter, the Supreme "compliance initiative" aimed at a specific market segment Court hears extremely few tax cases. Appeals court decisions (occupation, industry, geographic area or economic activity) are usually the final word in a tax matter. where an area of noncompliance has been identified. The 1RS also does a computer match of information documents, Interpreting Case Law such as for Forms 1099 and W-2, which can uncover discrepancies and result in an examination. Findings of the U.S. Supreme Court become law and must be followed by the 1RS. This is not the case with decisions of The Examination Process lower courts that find against the Government or Commis- sioner of Internal Revenue. In such cases, if the court finds If your return is selected for examination you will be notified in for the taxpayer in whole or in part, such findings are control- writing. The notification will inform you of the method of ling—assuming no appeal is made—only upon that particular examination and the records you will need to make available taxpayer for the years involved. The 1RS may, however, to the examiner to clarify or support entries on your return. concur with certain findings by formally issuing an announce- The examination may be conducted by correspondence, or it ment of "acquiescence." This means that the 1RS will apply may take place in your home or place of business, an Internal the findings of the court, as regards the specific points of law Revenue Service office, or the office of your attorney or involved, to other taxpayers as well. The 1RS may also accountant. Although the place and method of examination announce its "nonaquiescence," which means that it will not are determined by the 1RS, if the place is not convenient for follow the findings of the court and any taxpayer relying on you the examiner will try to work out something more this case as precedent very likely will be challenged by suitable. the 1RS. Whatever method of examination is used, you may act on In the process of interpreting and applying the Internal your own behalf or you may have someone represent you or Revenue Code to particular factual circumstances, the courts accompany you. If you filed a joint return, either you or your create nuances in the law. Since the Federal courts follow the spouse, or both, may meet with the examiner. An attorney, a common law system, relying on precedents instead of on a certified public accountant, a person enrolled to practice strict case-by-case reading of the statutes, court decisions before the 1RS, or the person who prepared the return and can be cited to support a position. Precedents must be used signed it as the préparer may represent or accompany you. appropriately, however. First, the precedent cited should be You must furnish your representative with written authoriza- "on point," i.e., deal with the same point of law as is involved tion. Form 2848, Power of Attorney and Declaration of in the present case. Second, the precedent should be Representative, or any other properly written authorization applicable to the jurisdiction in which the case would be tried. may be used for this purpose. Other cases from the same Federal district or circuit carry the most weight. Decisions from other districts or circuits may be Generally your tax return is examined in the 1RS District cited, but need not be followed unless the case has been where you live. However, at your request, the examination upheld by the Federal Appeals Court for the taxpayer's may be moved to another district for a reasonable cause. jurisdiction. U.S. Supreme Court decisions are precedent in any jurisdiction. Decisions by the Court of Appeals for the if You Agree—If you agree with the findings of the examina- Federal Circuit are precedent in the Court of Federal Claims. tion, you will be asked to sign an agreement form. If you owe additional tax, you may pay it when you sign the agreement. Audits and Appeals If you pay when you sign the agreement, interest is charged on the additional tax from the due date of your return to the Special audit programs have been developed to monitor date you pay. abusive tax shelters. Timber related activities are not gener- ally considered as abusive tax shelters. Although auditors are If you do not pay the additional tax when you sign the provided with special industry guidelines concerning what to agreement, you will receive a bill for it. The bill will include look for in auditing returns that report timber transactions, interest on the additional tax from the due date of your return your likelihood of being audited is not known to be increased to the billing date. If the tax is not paid within 10 days after the because of your timber activities. billing date, interest starts accruing again. If the examination

69 results in a refund you will receive interest at the applicable Along with your request for a conference, you may need to rate on the refund. file a written protest or brief statement of disputed Issues with your District Director. Such fillings are unnecessary if the If You Do Not Agree—If you do not agree with the changes proposed increase or decrease in tax, including penalties, or proposed by the examiner, the examiner will explain your claimed refund, due to a field examination is not more than appeal rights. This includes your right to request an immedi- $2,500 for any of the tax periods involved, or your examina- ate meeting with a supervisor to explain your position. If tion was conducted by correspondence or in an 1RS office by agreement is not reached at this meeting, or if the examina- a tax auditor. If the proposed increase or decrease in tax, or tion takes place outside of an 1RS office, the 1RS will send claimed refund, is more than $2,500 but not more than you: $10,000, an appeals office conference will be granted if a (1 ) A letter notifying you of your right to appeal the proposed brief written statement on the disputed issues is provided. adjustment within 30 days, You should list in the statement the unagreed adjustment(s) (2) A copy of the examination report explaining the proposed and the reason you disagree with each. A written protest of adjustments, disputed issues is required to obtain an appeals office (3) An agreement or waiver form, and conference if the proposed increase or decrease in tax, or (4) A copy of 1RS Publication 5, "Appeal Rights and Prepara- claimed refund, is more than $10,000. In addition, a written tion of Protests for Unagreed Cases." protest is required to obtain appeals consideration in all partnership and S corporation cases, as well as in two others. If after receiving the examination report you decide to agree See 1RS Publication 556 for more information on appeal with the findings, you sign the form and return it to the rights, including guidance on preparing a written protest. examiner. You may pay any additional amount and the applicable interest you owe without waiting for a bill. Appeals to the Courts

If after receiving the examination report you decide not to If you and the 1RS still disagree after your conference, or if agree with the examiner's findings, the 1RS urges you to you bypassed the appeals process within the 1RS, you may appeal your case within the 1RS before you go to court. Most take your case to the United States Tax Court, the United differences can be settled with an appeals office in the region States Court of Federal Claims, or your United States District without the need to go to court. Court as explained earlier. Even if you elect to bypass the IRS's appeals system, a case petitioned to the United States How To Stop Interest from Accruing—You can stop the Tax Court will normally be considered for settlement by an further accrual of interest on any amount the 1RS claims you Appeals Office before the Tax Court hears the case. If you owe or you believe they will claim you owe by remitting the are a prevailing party in a civil court case against the 1RS, appropriate amount to the 1RS. Your remittance may be made you may be entitled to recover reasonable litigation costs, If: either as a deposit in the nature of a cash bond (deposit) or (1) You exhaust all administrative remedies within the 1RS. as a payment of tax. If you also want to stop the accrual of (2) Your net worth is below a certain limit, and compound interest, you should remit any interest due. (3) You do not unreasonably delay the proceeding. Deposits differ from payments in that you can request the return of a deposit at any time without filing a claim for a For Information about procedures for filing suit in the courts, refund. However, deposits will not be returned if the 1RS has contact the Clerk of the Tax Court, the Clerk of your District determined that returning it will jeopardize collection of a Court or the Clerk of the Court of Federal Claims. Addresses possible deficiency or that it should';be applied against of the courts are given in 1RS Publication 556. another tax liability. Also, deposits do not earn interest. Claims for Refund—Once you have paid your tax, you have If at the end of the examination you agree with the findings of the right to file a claim for a credit or refund if you believe the the examiner, your deposit will be applied against the amount tax was calculated incorrectly and is too much. If you filed you owe. A notice of deficiency will not be mailed to you and Form 1040, Form 1040A, or Form 1040EZ, you may claim a you will not have the right to take your case to the Tax Court. credit or refund by filing Form 1040X, "Amended U.S. Individual Income Tax Return." Mail it to the Internal Revenue Appeals Within the 1RS Service Center where you filed your original return. A separate form must be filed for each tax year or period There is a single level of appeal within the 1RS. Your appeal involved. Include an explanation of each item of income, from the findings of the examiner is to an appeals office in the deduction, or credit on which you are basing your claim. region. This office is independent of the District Director. Appeals conferences are conducted as informally as pos- A claim for a credit or refund must be filed within 3 years from sible. If you want an appeals conference, address your the date the original return was filed (including extensions) or request to your District Director according to the instructions within 2 years from the date the tax was paid, whichever is in the letter you will receive. If agreement is not reached at later. Original returns filed before the due date are considered your appeals conference, you may, at any stage of the to have been filed on the due date. procedures, take your case to court.

70 Additional Information—For additional information consult 1197 (1956) (reversed in part and remanded), 1RS Publication 5. "Appeal Rights and Preparation of Protests 251 F.2d 163 (9th Cir. 1957). 18 TC.M. 202 (1959). which for Unagreed Cases," and 1RS Publication 556. "Examination happens to involve an oral agreement. By reading this case, of Returns. Appeal Rights, and Claims for Refund." you find that the court concluded that the oral contract in question was valid under the laws of the State in which it was Example of Tax Research executed because real property to be severed upon sale was not subject to the contract law generally applicable to a sale As an example of tax research procedures, assume you of real estate (Statute of Frauds didn't apply). Since the same execute an oral agreement to sell timber "on the shares" to a law applies in your state you conclude that your oral agree- logger. The logger agrees to cut your timber, sell the logs ment with the logger is an enforceable contract. But in produced to a sawmill, and give you 40 percent of the amount reading Ah Pah Redwood Co,, you note that the court ruled received from the sawmill for the logs. You are not certain that the taxpayer could get capital gains treatment under a how to report the payments you receive from the logger on disposal with an economic interest retained only if the your tax return, i.e., whether as capital gain or ordinary taxpayer was not holding the timber primarily for sale. This income, and how to recover your basis in the timber cut. court's ruling conflicts with the discussion in this publication, which says that disposals qualifying under Section 631 (b) From reading this publication, you are aware that capital receive capital gains treatment regardless of the purpose for gains treatment depends on how you dispose of timber and which the timber was held. Upon further investigation, the your primary purpose for holding it. If you "dispose" of timber index in the tax service refers you to Revenue Ruling 57-90 on the stump and the timber is a capital asset in your hands, (1957-1 C.B. 199) in which the 1RS notes that the finding of the proceeds are reported as a long-term capital gain if you the court in Ah Pah Redwood Co. will not be followed by the held the timber for more than 1 year. If you held the timber 1RS to the extent that it is inconsistent with the IRS's position primarily for sale to customers in the ordinary course of a that Section 631 (b) will be applied to a disposal of timber with trade or business, your disposal must meet the requirements an economic interest retained regardless of the taxpayer's of Section 631 (b) to qualify for capital gains treatment. If you business or the purpose for which the timber is held. sell products from your timber cut by you or by others providing a logging service for you, you do not qualify for In analyzing whether you have disposed of your timber with capital gains treatment on the proceeds from the sale of the an economic interest retained, you conclude that you in fact logs, but may elect to treat the cutting of the timber as a sale did dispose of the standing timber to the logger. Under the under the provisions of Section 631 (a) of the Internal Rev- oral agreement the logger was obligated to cut the timber, the enue Code. logger could sell the logs to any mill he chose, you could not dispose of the same timber to anyone else, and you had no Since you have conducted many timber sales from your land control over the logger's activities other than to assure that in the 20 years you have owned it, receive a substantial his activities didn't cause serious soil erosion or damage field portion of your total income from these timber sales, and in crops. general conduct your timber related activities in a manner consistent with being in the business of selling timber, you You also conclude that you retained an economic interest in conclude that your timber is held primarily for sale. the timber disposed of since you would be paid only for the timber actually cut and sold. The logger didn't agree to pay The next question is whether you have disposed of timber on you any fixed amount. the stump, or whether the logger is providing a logging sen/ice under the oral contract and is selling the logs pro- Therefore, you conclude that under the terms of the shares duced on your account. Since nothing in the Internal Rev- agreement in question, payments you received from the enue Code or regulations specifically deals with oral timber logger during the tax year qualify for long-term capital gains agreements, you must research case law for guidance. In the treatment under Section 631(b) of the Internal Revenue index of one of the tax services under "disposal with a Code, and that your allowable basis in the timber disposed of retained economic interest," you find several cases. The first can be recovered as discussed on page 36. one listed is Ah Pah Redwood Co. v. Commissioner 26 T.C.

71 Chapter Xlil. Sources of Tax Assistance

There are many sources of assistance available to you on 552 Recordkeeping for Individuals Federal taxation. The IRS*s taxpayer assistance program, for 556 Examination of Returns, Appeal Rights, example, has trained personnel answering toll-free taxpayer and Claims for Refund service phones to deal with many tax questions. Also, there 561 Determining the Value of Donated are publications by the 1RS and others dealing with Federal Property taxation, in general, and with the tax treatment of timber 584 Nonbusiness Disaster, Casualty, and Theft related activities, which can be complex. LossWorkbook 589 Tax Information on S Corporations 1RS Publications 909 Alternative Minimum Tax for Individuals 910 Guide to Free Tax Services The 1RS maintains a comprehensive taxpayer publications 925 Passive Activity and At-Risk Rules program designed to provide you with up-to-date tax informa- 946 How to Begin Depreciating Your Property tion. No 1RS publication deals specifically with timber, however. This publication supplements these taxpayer Commercial Tax Service publications by compiling the tax information directly impact- ing timber owners. The 1RS publications providing the general The following companies publish comprehensive Federal tax background needed to handle timber transactions are income tax information that is updated weekly. Many public cited in the text of this handbook. Single copies of 1RS libraries receive these publications, which discuss timber publications can be obtained at no charge from the 1RS. transactions under the applicable Internal Revenue Code sections. The following 1RS publications contain background informa- tion that may be helpful in understanding the tax treatment of Commerce Clearing House, Inc., 4025 W. Peterson Avenue, timber activities. Chicago, IL 60646, publishes "Standard Federal Tax Re- porter." Research Institute of America, Inc., 90 Fifth Avenue, Publication No. Title New York. NY 10011, publishes "Federal Tax Coordinator." 1 Your Rights as a Taxpayer 5 Appeal Rights and Preparation of Protests Other Sources for Unagreed Cases 17 Your Federal Income Tax Several other sources of tax information are available. Some 216 Conferences and Practice Requirements of these specialize in reporting current developments and 225 Farmer's Tax Guide providing tax tips, while others provide basic guidance on the (A comprehensive guide for farmers. This tax and related financial aspects of timber investments. taxpayer publication contains much information about timber transactions.) Current Developments 334 Tax Guide for Small Business (A comprehensive guide for owners of National Woodlands, published quarterly by the National small corporate and noncorporate Woodland Owners Association, has a timber tax column in businesses. Few timber transactions are each issue authored by William C. Siegel. The magazine also discussed.) provides tax legislative updates. The address is 463 Travel, Entertainment, and Gift Expenses 374 Maple Ave. E., Suite 210, Vienna, VA 22180-4751. 505 Tax Withholding and Estimated Tax 526 Charitable Contributions Forest Farmer, published by the Forest Farmers Association, 527 Residential Rental Property RO. Box 95385, 4 Executive Park East, N.E., Atlanta, GA 529 Miscellaneous Deductions 30347, is a magazine published six times per year. The Nov./ 533 Self-Employment Tax Dec. issue is devoted primarily to timber tax developments. 534 Depreciation All issues provide legislative updates. 535 Business Expenses 536 Net Operating Losses The Tree Farmer magazine, published by the American 537 Installment Sales Forest Foundation, Suite 780, 1111 19th Street NW, Washing- 538 Accounting Periods and Methods ton, D.C., includes regular updates of tax developments and 541 Tax Information on Partnerships in-depth discussions of relevant topics on a periodic basis. 542 Tax Information on Corporations 544 Sales and Other Dispositions of Assets The Natural Resources Tax Review \s published monthly by 547 Nonbusiness Disasters, Casualties, and Tax Analysts, 6830 North Fairfax Drive, Arlington, VA 22213. Thefts It covers tax and accounting issues affecting natural re- 550 Investment Income and Expenses sources, including timber. The full text of documents such as 551 Basis of Assets court decisions, 1RS rulings, and State administrative

73 documents are provided, as are in-depth analytical articles on "Financial Record Book for Timber Growers," by Jeffrey C. current issues. Stier and Peter K. Dederich, is available from the Department of Forestry, University of Wisconsin-Madison, Madison, Wl Guidebooks 53706. This loose-leaf book demonstrates each of the accounts associated with timber Investments and the "Christmas Tree Taxation Manual," by Vernon L. Bowlby. applicable tax law. Blank forms are included. C.P.A.. Bowlby Publishing Company, Inc., 310 N.W. 5th Street. Suite 103, Corvallis, OR 97330, featuring a loose-leaf Federal Income Tax Strategies for Timber Owners, featuring service and related materials available from the author, and written by Harry L. Haney, Jr., and William C. Siegel, is a provides a comprehensive guide to the tax treatment of 3-hour video-seminar and work-reference book. The loose- Christmas trees and an associated recordkeeping system. leaf work-reference book is updated annually. The video presentation of basic timber tax strategies is keyed to the 'Timber Tax Management for Tree Farmers," by William L work-reference book and includes timber examples and filled Hoover, is published by Department of Forestry and Natural out tax forms. It was produced by the University of Georgia Resources, Purdue University, West Lafayette, IN Center for Continuing Education and is available through the 47907-1159. This is a loose-leaf timber tax guide that is University of Georgia, Athens, Georgia. updated annually. The basic tax considerations of timber owners and strategies are covered. Comprehensive ex- Virginia Forests, published quarterly by the Virginia Forestry amples and associated filled out tax forms are included. Association, has a 'Taxing Questions" column written by Harry L Haney, Jr. in each issue. The magazine also "Essentials of Forestry Investment Analysis," by John E. provides legislative updates. The address is Gunter and Harry L Haney, Jr., is available from the Oregon 881 OB Patterson Avenue, Richmond, VA 23229-6322. Other State University Book Stores, Inc., P.O. Box 489, Corvallis, State forestry associations have magazines that provide tax OR 97339. This book describes the discounted cash flow and legislative updates. procedures used to analyze timber investments on a before-and after-tax basis. Procedures for accounting for the effects of inflation are also described.

74 Chapter XIV. Forest Records

Tax Purposes followed by you in other businesses or investments, or it may be different as dictated by the nature and scope of your Systematic and timely recording of timber transactions by timber activities. The two accounting methods in general use type, purpose, and amount is extremely important for a long- are cash basis and accrual basis. term forestry investment. Accurate records, coupled with a knowledge of the Federal income tax rules, allow you to With the cash basis method, revenue is reported when ensure fair tax treatment of the income and expenses actually or constructively received, and expenses are associated with your forest ownership as intended by deducted when actually paid. Most small service firms and Congress. Tax items that may be of interest to you as farms (including tree farms) have adopted cash basis discussed earlier include (1 ) qualifying timber revenue as accounting methods that are simple, flexible, and effective. long-term capital gain; (2) recovering invested capital through depletion, depreciation, and amortization; and (3) deducting Under the accrual basis method, revenue is recorded when it management expenses while complying with the passive is earned, whether or not you receive it at that time. Also, activity loss rules. Provisions concerning installment sales, expenses are deducted when they are incurred rather than involuntary conversions, like-kind exchanges, and cost-share when you actually pay them. Accrual accounting is preferred payments may also be important. by accountants and is used by many incorporated tree farm businesses. It has the advantage of evenly matching income As a general rule, you should keep accurate and complete and expense, so that revenues and costs are recorded closer documentation of your forestry activities to verify all entries to the time they actually occur. Thus, the accrual basis more made on tax returns. This includes invoices, contracts, nearly reflects economic activity—^which may or may not be receipts, canceled checks, and maps that validate woodland matched by a concurrent cash flow. One disadvantage of the holdings and forestry operations. See Form T (Timber) on accrual method is that it does not postpone the payment of page 122 for examples of the informational entries that may tax until cash is actually received. be required. Your woodland records should be preserved for a minimum of 3 years from the date the return reflecting them Taxpayers may use combinations of the cash and accrual is filed. This is the ordinary limit for audit by the 1RS. In some methods as long as the procedure adequately reflects income cases, this limit can reach to 6 years after the return is filed. If and is followed consistently. The installment method of a return is false or fraudulent, or if no return is filed, an action reporting revenues by an accrual basis taxpayer results in a by the 1RS can generally be brought at any time. The hybrid accounting method (see Chapter IX). 1RS approval is documents relating to acquisition of land, timber, and other generally necessary before an accounting method can be capital items—discussed in Chapter V— should be held for changed. the period of ownership plus a 3-year or longer period following disposition. Taxpayers should keep books and Recordkeeping Systems records adequate for audit (i.e., the books and records exist, are in proper form, and are readily accessible). An 1RS Shoe Box auditor could compel you to produce the records needed to audit your return. If you are unsure about the appropriate You should develop a systematic recordkeeping approach for records to keep after reading this chapter, you should consult your woodland records, even for the small tree farm held as with a qualified tax accountant as discussed in Chapter III. an investment. The much joked about shoe box system is better than nothing at all if organized and followed routinely. If Management Information you adopt this system, you can use business envelopes and label one for each tax category that applies to your woodland Good records are essential for a good forest management ownership. Then you would file a receipt or other document program as well as for tax purposes. They show the status of for each activity by category as it occurs. The categories that the timber inventory, timber growth rates, current cost and are important are discussed in previous chapters. revenue information, and projected cash flows for your tree farm. This information can be used to analyze the efficiency A Tree Farm Journal of proposed management options, enabling you to make informed choices in a timely manner. The records also serve To improve on the shoe box system, you should maintain a as historical documents to help you avoid repeating mistakes. journal to record forest management information. A journal is a chronological business diary that contains the details of Accounting Methods each business transaction—description, purpose, date, and dollar amounts involved. For example, see Forever Green You may adopt an accounting method that provides the most Tree Farm: Journal (Figure XIV-1). in addition to recording favorable tax treatment for your woodland ownership as long financial information on your woodland activities, you should as it "clearly reflects" income. It may be the same as one include the time expended on each if you will need such

75 information to establish the extent of your material participa- prevailing utilization standards when the property was tion for purposes of the passive loss rules as discussed in acquired (Figure XIV-3). It should also include that portion of Chapter V. For tree farmers with limited management the original purchase basis (see Chapter V) attributable to the activities, such a journal may provide a sufficient record of initial merchantable volume. transactions for tax purposes. However, you should sort entries by tax categories—capital transactions, deducttons from gross When premerchantable natural growth timber is acquired, income, deductions from adjusted gross income, timber sale its allocable portion of the total acquisition cost on an acreage revenue, expenses of timber sale activities, and others. basis is established in a young-growth subaccount (Fig- ure XIV-4). You are required to establish a premerchantable A Tree Farm Journal With Accounts subaccount if the young growth makes a substantial contribu- tion to the total value of the woodland property (see Chap- As forestry operations increase in complexity, a journal ter V). The premerchantable timber basis is transferred to a becomes most useful as a diary of day-to-day tree farm merchantable account as the young growth reaches mer- activities that can be transferred (posted) systematically to chantability. Merchantability standards vary with local market appropriate accounts. Ledger accounts are established for conditions. An estimate of the volume per acre being trans- each separate business or tax activity needed for efficient ferred is also required, as the unit for measuring timber operation of the business, and for the timely reporting of changes from area to volume. The transfer is made by financial and tax information. increasing the basis and volume in the merchantable timber account while reducing the basis and acreage in the young The number and kind of ledger accounts will vary with the growth account by a corresponding amount. In the example details of your forestry business. Accounts typically used that follows, the basis of $12,415 and an estimated merchant- include those that are specifically related to timber operations able volume of 1.350 cords on the 60 acres are transferred to plus those that are generally needed for any business. Only a merchantable pulpwood account (not shown). the basic accounts needed to illustrate tree farm records are introduced here. To save space, repetitive costs (e.g., annual A Reforestation subaccount (not shown) is similar to the property taxes) are shown in the journal only once. Forestry premerchantable subaccount. It is created when a new timber expenditures accounts include accounts for both capital and stand is established by artificial regeneration (planting or expense items, as discussed in Chapter V. Revenues are seeding) following a harvest. Replanting costs following a placed in either capital gain or ordinary income accounts. failure of the initial establishment effort must also be capital- ized. Note, however, that if Revenue Ruling 90-61 (page 94) Capital Accounts applies, the basis in the property subject to failure may be reduced. Tree farm assets generally include (a) land, (b) timber and (c) improvements. Each item that adds significantly to the Amortization of reforestation is an account for recording value of the property should be reflected in an account. Then qualified reforestation amortization. An account must be when an item is disposed of, worn out, or used up, it can be established for each year that qualified expenditures are properly treated with respect to its contribution to the produc- made (see Chapter V, page 24, and Table XIV-1. item no. 17). tion of income. Depreciation accounts are established for equipment and The Land account contains entries for the land and land other depreciable assets that are used on your tree farm (see improvements (Figure XIV-2). Permanent land improvements Figure XIV-5 and Table XIV-1, item no. 4). The cost of include such things as nondepreciable roadbeds of roads, equipment used in forestry operations is established in land leveling, and impoundments—items that have indetermi- subaccounts according to the procedures discussed in nate useful lives. The amounts for land and nondepreciable Chapter V, page 18. Bridges, culverts, gravel surface on a land improvements should not be combined in the basis of road, and fences are examples of depreciable land improve- the land account because events may require you to substan- ments for which subaccounts may also be established. They tiate the basis of an improvement. For example, if a casualty are depreciable because they wear out and have a determin- resulted in destruction of a roadbed, you would need to know able useful life. The cost of such items must be depreciated the basis in the affected property in order to claim a casualty rather than deducted currently because their determinate loss. The basis in the land account is recovered for tax useful life is greater than 1 year. proposes as an offset against income when the land is sold or othenA^ise disposed of. Expense Accounts

A Timber account may contain subaccounts for merchant- The number of expense accounts that you need depends on able timber, nonmerchantable young natural growth, and the nature of your operations. Property taxes, travel ex- plantations. One or more merchantable accounts may be penses, and expenditures for various timber stand mainte- kept, depending on your management goals, but a single nance operations are some of the typical costs that you may averaging account is the simplest for small to medium sized incur (e.g., see Table XIV-1). Maintenance operations include woodlands. A merchantable timber account should include such activities as precommercial thinning, prescribed burning the merchantable volume that could have been harvested at for hazard reduction, the purchase of small tools and sup-

76 Table XIV-1—Forever Green: Tree Farm Accounts 11. Road Maintenance Fief. 13 897 Debits Credits 20 578 $ $ 12. Property Tax Expense 1. Cash Account 14 410 1 2,500 34 640 2 81,180 36 640 3 4,000 13. Timber Stand Improvement 11 8,868 12 421 25 1,500 13 1,696 14. Timber Sale Revenue 14 410 16 7,884 15 4,730 17 70,956 16 7,884 &al. fwd. 78,840 17 70,956 15. Cost of Timber Sold (Basis) 19 12,500 18 54,934 20 930 16. Expenses of Sale 21 5,000 15 4,730 23 3,600 17. Amortization of Reforestation 1,500 25 22 509 165,250 26 24 1,262 27 6,400 33 276 18. Hunting Lease 34 640 38 600 35 15,201 38 600 plies, and equipment maintenance. See also Chapter V for a 2. Temporary Capital Account" discussion of forestry expenses and their tax treatment, 1 2,500 including the effect of the passive loss rules. 2 188,180 3 4,000 Capital Income Accounts 4 194,680 26 165,250 Timber normally generates capital gains or losses when you 27 6,400 dispose of it (see the discussion on capital gains in Chap- 28 171,650 ter VI). Accounts associated with timber dispositions include 36 5,454 those for Timber Sale Revenue, Cost of Timber Sold (Basis), 37 5,454 and Timber Sale Expenses (Table XIV-1 ; and accounts 14, 3. lUlortgage Payable 15, and 16, respectively). 2 100,000 11 3,700 Ordinary Income Accounts 6al. fwd. 96.300- mrm: i55:2äif" Ordinary income may be generated in many ways from a tree 35 10,663 * farm. In fact, most income other than that from the sale of 44,568 Ëal. fwd. timber or perhaps land, will be ordinary income. Examples ' Repetitious data omitted. are hunting lease payments, selling firewood from logging 4. Depreciation Expense slash, sale of wild nuts, and sale of pine straw. Since ordinary 10 467 income may be important for offsetting management ex- 5. Accumulated Depreciation penses, appropriate accounts should be established to record 10 467 it. A Hunting Lease Account illustrates this point (see Table 6. Interest Expenses XIV-1, ref. 38). ii 5,160 • 35 4,538 General Business Accounts 36 4,538 * Repetitious data omitted. You also need to establish accounts that are basic to any 7. Travel Expenses business. A cash account is used to handle revenues, pay 276 bills, and make allocations to other business accounts. Other 36 276 categories of accounts for accumulating cash flows for 8. Operating Expenses business or tax decisions include: Interest Expense, Travel 12 421 Expense, Vehicle Maintenance, Depreciation Expense, 9. Truck Maintenance Accumulated Depreciation, Mortgage Payable, and 217 13 Miscellaneous. These are shown in Table XIV-1 in abbrevi- 10. Bridge Maintenance ated form in order to provide continuity with the forestry 13 352 accounts (Figures XIV-2 through XIV-6) in the following 20 example of a tree farm purchase.

77 Comprehensive Example XIV-1 refs. 16 and 17, respectively). The cost of timber sold (allowable basis) is calculated using information from the Records for a Tree Farm Purchase: Forever Green Tree Merchantable Sawtimber Account (Figures XIV-3 and XIV-6). Farm was purchased by Red Oaks from B. Smith on June 1, This amount of $54,934 (ref. 18) is recorded In Account 15. 1988, for $194,680. Red Oaks subsequently purchased the Cost of Timber Sold (Table XIV-1). adjoining Lonesome Pine tract on September 2,1993, from Mountain Realty Company for $165,250. The journal entries The harvested 60 acres is site prepared for reforestation to record the acquisition of these properties, the allocation of (Figure XIV-1, ref. 19). Red Oaks received FIP cost-share the purchase price to the respective capital accounts, the payments of $5,000 (ref. 21). The amortization schedule is payment of annual operating expenses, the selling of timber, shown in Table XIV-4. The first year amortization deduction is and the reforestation of the harvested stands are shown in shown in Table XIV-1, Account 17. Amortization of Reforesta- the Forever Green Tree Farm Journal (Figure XIV-1). They tion (ref. 22). The expenditures for reforestation are recorded are then transferred (posted) to the respective capital in the Reforestation Account (not shown). The site prepared accounts (Figures XIV-2 through XIV-6) and to the general tract was planted the following year for $3,600. for which no business accounts that are shown in abbreviated form in cost-share payment was received (Figure XIV-1, ref. 23). The Table XIV-1. amortization is shown in Table XIV-1. Account 17.

An example of each type of transaction is briefly explained to Red Oaks spent $1,500 on timber stand improvement illustrate the process of handling various cash flows and the operations in order to maintain the quality and growth of tax treatment each should receive. The consulting forester's selected trees. This is a deductible expense shown in appraisal for the Forever Green property is shown in Table XIV-1, Account 13, ref. 25. His timber ownership is Table XIV-2. The appraisal cost of $2,500 (Figure XIV-1. assumed to be a business and he is assumed to be materi- ref. 1) and the legal fees of $4,000 (Figure XIV-1, ref. 3) are ally participating in the operations. capital acquisition costs for purchasing the property. They are added to the $188,180 purchase price (ref. 2) of the property In 1993, the adjoining trad was purchased by Red Oaks. The that was allocated to the capital accounts. The initial book- purchase and allocation of capital is similar to the establish- keeping is handled with a temporary capital account that ment of the original accounts. These addittons show the reflects the $194,680 total cost of the acquisition (ref. 4). adjustments to basis in the Land Account (Figure XIV-2, ref. Allocation of the acquisition cost to the capital accounts is 29); Merchantable Timber (Figure XIV-4, ref. 30b, and Figure shown in Table XIV-3. The basis in land is recorded in the XIV-6, ref. 30); and Young Growth (Figure XIV-4, ref. 31 ). Land Account (Figure XIV-2, ref. 5). Similarly, the basis in merchantable timber is recorded in the Merchantable When the young growth in the original purchase reached Sawtimber Account (Figure XIV-6, ref. 6a) and to Merchant- merchantability in 1993, it was transferred from the Young able Pulpwood (ref. 7, but not shown). A corresponding Growth Account (Figure XIV-4, ref. 32) to the Merchantable estimate of the merchantable volume—650 MBF—is reported Pulpwood Account (not shown). Note that this is an option in the Merchantable Sawtimber Account (Figure XIV-3, chosen by Red Oaks based on his timber management ref. 6b). The young growth is recorded in the Young Growth goals. He is keeping the merchantable accounts separate by Account (Figure XIV-4, ref. 8). The basis of the bridge is products (i.e., sawtimber and pulpwood), although they could posted to the Depreciable Land Improvement Account have been combined into a single merchantable account. (Figure XIV-5, ref. 9). It is depreciated using a straight line method with a 15-year recovery period and an assumed In 1993, Red Oaks' fortunes were not good, resulting in zero salvage value of zero. The first year depreciation deduction is taxable income. He elected to capitalize as carrying charges shown in Table XIV-1 (No. 4, ref. 10) and the depreciation is the expenses for travel (Figure XIV-1, ref. 33), property taxes accumulated in Account No. 5 (ref. 10). The information in (ref. 34), and business interest (ref. 35). The total of $5,454 is these accountants should be used to complete Schedule B proportionately allocated to the timber accounts (Fig- (Acquisitions) of Form T (Timber) if it is filed with your Federal ure XIV-1, ref. 37). income tax return. Form T should be completed and filed with your records even if not required to be filed with the 1RS. The diversity of Forever Green Tree Farm—mixtures of timber species, various age classes, and openings caused by The business loan on Forever Green Tree Farm is amortized, han^esting—offered good hunting prospects. Red Oaks and the interest expense, which is deductible (Figure XIV-1, leased the property for 5 years to the Laid Back Hunt Club for ref. 11), and reduction of principal, which is not deductible $600 per year ($2 per acre per year). Most members are (Table XIV-1, Account 3), are recorded in separate accounts. neighbors, and the agreement included clauses for insurance coverage, fire protection and prevention of trespass. The first Various operating expenses for the Forever Green Farm that payment was received at the beginning of 1994 (Table XIV-1, are also shown in Table XIV-1 include those for supplies ref. 18 and Figure XIV-1, ref.38). (ref. 12), maintenance (ref. 13), and property taxes (ref. 14). See chapter V for a discussion of expenses, including Blank ledger forms for beginning a Tree Farm journal and treatment of the business interest discussed above. Accounts for Merchantable Timber, Young Growth, and Reforestation are shown in Appendix IV. These are the When Red Oaks planned to sell timber in 1990, he hired a minimum needed for efficiently recording information in tree consulting forester to prepare the sale for a fee of $4,730 farm capital accounts. Other general business accounts such (ref. 15). The bid deposit and balance of the sale income are as those suggested in Table XIV-1 should be added as recorded in Account 14, Timber Sale Revenue (Table XIV-1, needed to reflect the complexity of your tree farm operations.

78 Table XiV-2—Summary of Cruise Reports for Forever Green Tree Farm and Lonesome Pine Tree Farm Purchases Description of Assets Value Forever Green Tree Farm (01/15/88): 1. 200 acres of average site land @ $300/acre = $ 60,000

2. Merchantable pine and mixed hardwood sawtimber on 100 acres ^ Pine—400 MBF @ $165/MBF = $66,000 Hardwood—250 MBF @ $90/MBF = $22,500 88,500 3. Pulpwood—pine and mixed hardwood on 40 acres'' Pine—880 cords @ $15/cord = $13,200 Hardwood—320 cords @ $9/cord = $2,880 16,080

4. Young growth pine averaging 8 years old on 60 acres 60 acres @ $200/acre = 12,000

5. Used wooden bridge—90 feet (15-year recovery period with no salvage value). 11,600

Total estimated fair marlcet value: $188,180

Lonesome Pine Tree Farm (08/01/93):

1. 120 acres of fair quality land @ $250/acre = 30,000

2. Merchantable pine-hardwood sawtimber on 80 acres'' Pine—470 MBF @ $195/MBF = $91,650 Hardwood—280 MBF @ $120/MBF = $33,600 125,250

3. Young growth pine averaging 5 years old on 40 acres 40 acres @ $250/acre = 10,000

Total estimated fair market value: $165,250

^ Submitted by E.Z. Cruiser, Registered Forester No. 424.

Table XIV-3—Allocation of Forever Green Tree Farm Assets to Capital Accounts

Account Fair market value Percent of total Allocation of Original cost basis (FMV) FMV acquisition cost ($) (%) ($) ($) Land 60.000 31.88 2,073 62,073 Sawtimber 88,500 77.03 3,057 91,557 Pulpwood 16,080 8.55 555 16,635 Young growth 12,000 6.38 415 12,415 Bridge 11,600 6.16 400 12.000 Total 188.180 100.00 6,500 194.680

79 Table XIV-4—Forever Green Tree Farm: Reforestation Tax Credit and Amortization Scheduies

For 1991 Federal tax returns: Site preparation cost (see ret. 19) $12,500 Less PIP cost-share payment (see ref. 21 ) $ 5,000 (Payment exiuded from gross income), Total out-of-pocket reforestation cost eligible for credit and $ 7,500 amortization Investment credit (report on 1RS Form 3468): $7,500 x10%= $ 750 Amortization schedule (report on 1RS Form 4562): (1 ) Reduce amortizable basis by one-half of credit claimed: $7,500- ($750 X.5)= $ 7,125 (2) Compute deductions over 84 months (8 tax years) using one-half year convention (i.e., only 6 months is claimed in first and last years) 1991 and 1998 returns (see ref. 22) $7,125 X (1/14)= $ 509 1992-1997 returns (see ref. 24) $7,125 X (1/7)= $ 1,018

For 1992 Fédérai tax returns: Planting cost (see ref. 23) $ 3,600 Total out-of-pocket reforestation cost eligible for credit and $ 3,600 amortization (i.e., cost-share payment was not received on this activity) Investment credit $3,600x10%= $ 360 Amortization schedule (1 ) Reduce basis for credit taken $3,600 - ($360 X .5) = $ 3,420 (2) Amortization deductions: 1992 and 1999 returns (see ref. 24) $3,420 X (1/14)= $ 244 1993-1998 returns $3,420 X (1/7)= $ 489

80 Figure XIV-1—Forever Green Tree Farm: Journal

Date Accounts and Explanation Ref. Debits Credits ($) ($) 06/01 /88 Temporary capital account 2.500 Cash 2.500 E.Z. Cruiser, Consultant forT.F. appraisal report 06/01 /88 Temporary capital account 188.180 Cash 88,180 Mortgage payable 100.000 Purchase Forever Green tree farm 06/15/88 Temporary capital account 4,000 Cash 4.000 S. Lawyer, attorney for title search, filing, and closing 06/21 /88 Land—Lonesome Pine tract (fig. XIV-2) 5 62.073 Merchantable sawtimber (figs. XIV-3, 6a 91,557 XIV-6) Merchantable pulpwood (not shown) 7 16.635 Young growth (fig. XIV-4) 8 12.415 Equipment (bridge, fig. XIV-5) 9 12,000 Temporary capital account 4 194,680 Allocation of tree farm purchase to permanent capital accounts 12/31/88 Depreciation expense 10 467 Accumulated depreciation 467 First year depreciation of bridge 12/31/88 Interest expense 11 5.168 Mortgage payable 3,700 Cash 8,868 Interest expense and mortgage principal reduction for 1988 (See Interest Expense and Mortgage Payable Accounts in Table XIV-1.) 01/15/89 Operating expense 12 421 Cash 421 Forest Suppliers for purchase of axes, posted signs, flagging 06/01/89 Bridge maintenance 13 582 Truck maintenance 217 Road maintenance 897 Cash 1,696 Forestry expenses for servicing truck, grading, pulling ditches, and repairing bridge 12/31/89 Property tax expense 14 410 Cash 410 Treasurer, Local County 02/15/90 Expenses of sale (table XIV-1 ) 15 4,730 Cash 4,730 E.Z. Cruiser, consultant for sale preparation (see also table XIV-2)

81 Figure XIV-1—Forever Green Tree Farm: Journal (cont'd)

Date Accounts and Explanation Ref^ Debits Credits

04/10/90 Cash 16 7.8B4 Timber sale revenue 7,884 Deposit (10%), on timber sale from Sawyer Lumber Co. 05/07/90 Cash 17 70,956 Timber sale revenue 70,956 Balance of sale revenue from Sawyer Lumber Co. (see also table XIV-1 )

12/31 /90 Cost of timber sold ^ 18 54,934 Merchantable sawtimber account (value) 54,934 Allowable as basis for sale Merchantable sawtimber account (see also chapter VI) 06/15/91 Reforestation account (not shown) 19 12,500 Cash 12,500 B. Roller, contractor for site preparation on 60 acres of cutover land 08/26/91 Bridge maintenance 20 352 Road maintenance 578 Cash 930 M. Truck, contractor for road grading, bridge repair 09/01/91 Cash 21 5,000 Reforestation account (not shown) 5,000 ASCS, receipt of FIP cost-share payments on site preparation (see also table XIV - 2) 12/31/91 Amortization of reforestation 22 509 Reforestation account (not shown) 509 Amortization of site preparation (see table XIV-4) 02/10/92 Reforestation account 23 3,600 Cash 3,600 E.Z. Cruiser, contractor for planting pine on site prepared 60-acre cutover tract (see table XIV-4) 12/31/92 Amortization of reforestation 24 1,262 Reforestation account (not shown) 1,262 Second year of site preparation ($1,018) and first year of planting amortization ($244) (see table XIV-4) 08/06/93 Timber stand improvement 25 1,500 Cash 1,500 R. Axman, contractor for timber stand improvement in 60-acre natural pine stand Volume removed in sale (see Form T) 438 MBF, is adjusted in Merchantable Sawtimber Account (Figure XIV-3).

82 Figure XIV-1—Forever Green Tree Farm: Journal (cont'd)

Date Accounts and Explanation Ref. Debits Credits ($) ($) 09/01/93 Temporary capital account 26 165,250 Cash 165,250 Mountain Realty Co., acquire Lonesome Pine—120 acres total 09/02/93 Temporary cash account 27 6,400 Cash 6,400 Mountain Realty Co., appraisal, title search, legal fees, etc. to acquire Lonesome Pine 09/15/93 Total cost of property (6,400 + 165,250) 28 171,650 Land 29 31,162 Merchantable sawtimber (figs. 12 and 15) 30a 130,101 Young growth 31 10.387 Allocation of Lonesome Pine purchase to permanent capital accounts 09/31/93 Pulpwood timber 32 12,415 Young growth 12.415 Young growth transferred lo pulpwood timber account (value not shown) 11/01/93 Travel expense 33 276 Cash 276 Routine inspection of boundaries, roads, and fire lines from travel diary (not shown) 12/31/93 Property tax expense 34 640 Cash 640 To Local County Treasurer for property tax expenses 12/31/93 Interest expense 35 4,538 Mortgage payable 10,663 Cash 15.201 Interest expense and mortgage principal reduction for 1993 12/31/93 Capital account 36 5.454 Travel expense 276 Property tax expense 640 Interest expense 4.538 Election to capitalize carrying charges for 1993 12/31/93 Capital account 37 5,454 Merchantable sawtimber account 3,808 Pulpwood account (not shown) 1,349 Young growth account 297 Allocation of carrying charges to timber accounts 1/1/94 Cash 38 600 Hunting lease 600 Receipt of hunting lease payment from Laid Back Hunt Club

83 Figure XIV-2—Forever Green Tree Farm: Land Account "TJate Description of Activity Het. üeDits Credits • ' J $ 06/21 /88 Allocation of Forever Green T.F. 5 62,073 cost to land: Oaks Tract (see table XIV-3) 09/15/93 Allocation of Lonesome Pine 29 31.162 purchase cost to land 09/15/93 Adjusted balance (basis) carried 93,235 foHA^ard

Figure XIV-3—Forever Green Tree Farm: Merchantable Sawtlmber Account—Volume* "üäte Description of Activity Het. Additions Hemovals " ' MBF 06/21/88 Estimated merchantable volume of 6b 650 pine and hardwood sawtimber at date of purchase (see Forever Green T.F. cruise in table XIV-2) 01 /02/90 Growth for 1988-90 (2 years: see 80 cruise report, table XIV-2) _^ .^_ 01 /02/90 Adjusted volume carried forward 730 12/31/90 Volume removed in sale 18b f^8 12/31/90 Adjusted volume carried forward 292 09/15/93 Estimated volume on Lonesome 30b 750 Pine when purchased (see table XIV-2) 09/31 /93 Adjusted volume carried fon/vard 1,042 * See figure XIV-6 for corresponding value.

Figure XIV-4—Forever Green Tree Farm: Young Growth Account Date Description ot Activity Ret. Debits % Credits"r 06/21/88 Allocation of Forever Green T.F. 8 12,415 purchase cost to young growth (60 acres of pine, see table XIV-3) 09/15/93 Allocation of Lonesome Pine purchase cost to 31 10,387 young growth (40 acres, see table XIV-3) 09/31 /93 Transfer young growth to Merchantable 32 12,415 Pulpwood Account (value); volume estimated (cruised) to be 1,350 cords by E.Z. Cruiser 09/31 /93 Adjusted balance carried iomard T5T357 12/31/93 Election to capitalize carrying costs, 37 297 proportional allocation 12/31/93 Adjusted balance carried fon/vard 10.684 ""

84 Figure XIV-5—Forever Green Tree Farm: Depreciable Land Improvement

Date bescription of Activity" ReT Debits Credits $" T 06/21 /88 Allocation of Forever Green T.F. 12.000 purchase cost to equipment, a 90-foot wooden bridge (see table XIV-3) 12/31 /88 Depreciation deduction for 1988 [(straight 10 467 line)—($12.000/15) x 7/12 months] 12/31 /88 Adjusted balance carried fonward 1i.5àà (Subsequent depreciation entries are not shown.)

Figure XIV-6—Forever Green Tree Farm: Merchantable Sawtlmber Account (Value) Date Description of Activity Ref. Debits Credits $ $ 06/21 /88 Allocation of Forever Green T.F. purchase cost to 6a 91.557 timber 12/31 /90 Allowable as basis for sale 18a 54,934 12/31 /90 Adjusted basis carried fon/vard 36,623 09/15/93 Allocation of Lonesome Pine purchase to timber 30a 130,101 (see table XIV-2) 09/15/93 Adjusted basis carried fonward 166,724 12/31/93 Election to capitalize carrying charges 37 3,808 12/31 /93 Adjusted basis carried fon^^ard 170,552

85 Glossary

Accounts. A record of all transactions that affect one account. The capitalized amount is recoverable through segment of a business. Examples are a cash account, land depreciation, depletion, amortization, or sale or exchange of account, merchantable timber account, and depreciation property. account. Carrying Ctiarge. Expenditures made to carry an asset, that Alternative Minimum Tax, The excess, if any, of a is, maintain possession. Examples are interest, taxes, and taxpayer's tentative minimum tax for a tax year over his (her) insurance. regular tax for that tax year. The Code defines tentative Casualty. An identifiable event of a sudden, unexpected, and minimum tax for various categories of taxpayers. unusual nature. The complete or partial loss (destruction) of Amortization. The process by which the basis of certain property resulting from a casualty is known as a casualty capital assets, such as qualifying reforestation expenditures, loss. is recovered. The rate of recovery is based on a set time Code. Refers to the Internal Revenue Code of 1986, as period. amended. This is the written tax law as enacted by the U.S. Basis. In general, the amount paid for property, including Congress. The Department of the Treasury issues regulations expenditures made in connection with the purchase, is the to interpret the Code. Revenue rulings published by the 1RS basis of the property. The basis of property acquired by other provide information and guidance in applying the tax law and means is determined by the manner of acquisition (for regulations correctly and uniformly. determining the basis of property acquired by inheritance or Condemnation. The lawful taking of private property by a gift, see page 17). government body for public use without the consent of the Adjusted—^The original basis less any reductions owner, with payment of compensation. made because of depreciation, depletion, amortization, Conversion Cost. The cost of converting standing timber or losses claimed, plus any additions, made by capitali- into a salable product, such as logs, lumber, and railroad ties. zation of improvements, carrying charges, or additions In the case of producing lumber, the costs include those to the asset. incurred to cut down (fell) the trees, cut off the limbs, section Aiiowabie.—The portion of the adjusted basis that can the tree stem into logs (buck), move the logs to a point where be offset against the revenue received when standing they can be loaded on a truck (skid), transport the logs to a timber is sold or othen^^ise disposed of. sawmill and saw the logs into lumber. Sfepped-up.—Assets acquired by inheritance take as Cord. A unit of measure used in conjunction with timber to be their basis the fair market value of the asset on the converted into pulpwood, firewood, or other products that are deceased's date of death or on the alternate valuation not produced or measured in terms of board feet. A standard date. This value is generally greater than the basis of cord is a 4x4x8 foot stack of wood. the asset in the hands of the deceased. The basis is Credit. An amount allowed as an offset against income tax therefore stepped-up (increased) in passing from the for a particular tax year. deceased to the person inheriting it. Cruise. The process by which the volume, type, and quality Benefit Cost Ratio. The discounted present value of all of timber within a designated area is determined. The cruise revenues from an investment divided by the discounted value can be made by actually measuring the dimensions of each of all costs. It is usually expressed as a ratio such as 1.10 to tree, referred to as a timber inventory. A cruise can also be 1.0 if the benefits were 10 percent greater than costs. made by measuring only those trees selected in a statisti- Board Foot (bd, ft./ The standard of measure of certain cally-based sampling scheme. If the timber within the trees, logs, and other products cut therefrom. The unit is one designated area is uniform, the total volume within the area foot square and one inch thick. Tables based on various "log can be estimated to a predetermined level of accuracy by rules" are used to convert tree and log lengths and diameters measuring the trees on a portion of the total area. into board foot volumes. Depletion. The using up or wasting away of a natural Business. Generally, an activity carried out for the realization resource. In the case of timber, it is the recovery of the of a profit and characterized by regular transactions. Neither owner's basis in timber, referred to as "depletion allowance." the Code nor Regulations provide a precise definition of the The term applies when timber is cut by the owner, and the term 'Irade or business." logs cut from the timber are sold or used in the owner's Capitai Account. An account used to keep track of the basis business. and quantity of such assets as land, timber, buildings, and Average.—If all of the timber from more than one tract equipment. and of various grades and species is included in one Capital Gain or Loss. Generally, the gain or loss realized on timber account, the depletion unit, and therefore the the sale of exchange of capital assets such as land, timber, depletion allowance or allowable basis, is an average of buildings, and equipment. Income received in this manner is all the timber in the account. treated differently for tax purposes than income received in Species or Value.—Under certain conditions, it may be the form of wages or salary, or the profit realized from the permissible to maintain separate timber depletion operation of a business. accounts for individual species, value, or product classes Capitalize. The process of adding the amount paid for of timber from one or more tracts. property and additional qualifying expenditures to a capital

87 Depreciation, The process by which the basis of assets, some states, they are available for a limited amount of such as equipment, buildings, and fences, is recovered as on-the-ground assistance to individual landowners. the assets are used for the production of income. /ndusfry.—Foresters employed by a timber growing and/ Disposal. Timber is disposed of when the owner cuts, sells, or processing company. They frequently provide techni- or exchanges timber, or otherwise parts with the property. In cal assistance in conjunction with timber purchased from the case of a 631 (b) transaction, timber is disposed of when private landowners. Many companies also have formal the owner transfers cutting rights to another under a binding programs through which they make their foresters contract obligating the seller to sell and the purchaser to cut available to assist landowners in all aspects of timber at the time cutting begins. management. Economic Interest This concept was developed by the U.S. Service.—Also referred to as "District" or "State" Supreme Court to determine which taxpayers in addition to foresters, they are employed by the state agency the fee owner of property qualify for certain tax benefits. charged with responsibility for protecting the state's Section 631(b), discussed on page 34, requires that an public and private forest lands. These foresters are economic interest be retained. An economic interest is available for a wide variety of services, although the retained in every case in which the taxpayer has acquired by amount of time they can devote to any one landowner is investment any interest in standing timber and secures, by generally limited. They also approve and certify financial any form of legal relationship, income derived from the assistance to landowners under the Forestry Incentives severance of the timber to which the taxpayer must look for a and Agricultural Conservation programs. Their services return of capital. are usually free. Equal Annual Equivalent This is the net annual return (or Girdling. The process of encircling the trunk of a tree with a cost) over the life of an investment for a given discount rate. It cut that stops the flow of nutrients between leaves and roots, is similar to an installment payment over the life of a loan. resulting in the death of the tree. Establishment Cost The funds spent to prepare a site for Hobby. An activity engaged in without the primary intent of tree planting or seeding, for seedlings or tree seeds, and for realizing a profit. hired labor associated with reforestation, including supervi- Income. sion. The establishment cost may also include some expendi- Active.—\ncotne generated by a trade or business tures made after seeding or planting, such as for brush activity in which the taxpayer material participates. control, because a stand is not considered established until a Capital.—See capital gain. number of individual stems sufficient to adequately stock the Farm.—Income received from the sale of agricultural site with the desired species are capable of surviving (see commodities such as grain, livestock, fruit, vegetables, summary of Revenue Ruling 76-290, page 92). dairy products, poultry, and fish. Executory Contract A contract that specifies the agreement Ordinary.—Income received in the form of wages, reached between the contracting parties, but that does not salary, rent, etc. become effective unless and until some specified event or Passive.—Income generated by a trade or business action has occurred. A timber sale contract may, for example, activity in which the taxpayer does not materially specify that the timber is not sold under the contract until the participate. buyer has cut the timber and determined the volume cut. Portfolio.—Income generated by certain investment Expensing. Recovery of expenses by deducting them in full activities. in the year they are paid or incurred. Information Return. A prescribed 1RS form whereby Fair Market Value. The price at which property would change taxpayers are required to report certain activities with third hands between a buyer and a seller, neither being required to parties to the 1RS with a copy to the third party. buy or sell, and both having reasonable knowledge of all the Installment Sale. A sale in which at least one payment is necessary facts. received by the seller after the tax year in which the disposi- Farm. Generally, a trade or business producing '1arm tion occurs. income." Specific Sections of the Code more precisely define Internal Rate of Return. Average compound interest rate farming for purposes of that particular section. Many Code earned over an investment period. sections specifically exclude the production of timber from the Investment An activity engaged in with the intention of definition of farming. realizing a profit, but not rising to the level of a trade or Felled Timber. Timber in trees that have been cut down business. (severed) and are lying on the ground. Involuntary Exchange. The exchange of an asset, for Forester. money or other property, when the exchange results from a Consulting.—Foresters for hire on a contract basis. cause beyond the control of the owner, such as a casualty, They charge a daily fee plus expenses for certain types theft, or condemnation. of services and provide other services on a fixed cost Journal. A record of business transactions recorded in contract basis. Some charge a fixed percentage of the chronological order. It usually shows the date, amount of sale price to provide all or a portion of the services transaction, description including names, and the accounts required in connection with timber sales. affected. £xtens/on.—Foresters employed by the Cooperative Ledger. A book of accounts. Extension Service of the state. They are usually based at Lessee. The person to whom the lease is made, for example, the state's land-grant university. Their primary function is the timber company in the case of a timberland owner who to provide educational materials and related services. In leases land to a timber company.

88 Lessor. The person granting the lease, for example, a estimate the volume of the logs or trees by applying the timberland owner who leases to a timber company the right to dimensions to a log rule or tree volume table. cut and grow timber on the land. Severance Tax. A state excise tax on the cutting of timber. In Log Rule. A measuring formula that gives the relationship most states in which the tax is levied, it is in addition to any between the diameter and length of a log and the board foot property taxes levied or taxes in lieu of property taxes. Funds volume of lumber which could be sawn from the log. It is generated are often designated for specific forestry-related assumed that the entire log is sawn into one-inch thick purposes such as fire control, reforestation, and public boards. Several rules have been developed based on varying forestry assistance. assumptions about the thickness of the saw and sawing Site Preparation. The preparation of land for the planting of practice used. Some of the standard rules are International 1/ tree seedlings or tree seeding. The objectives include 4 inch, Scribner decimal C, and Doyle. reduction of brush and other obstacles to allow planting Lump Sum Sale. The outright sale, usually by means of a equipment to operate, reduction of vegetation that would timber deed or sale contract, of standing timber for a fixed compete with young trees, scarification of the soil to provide a total amount agreed upon in advance, suitable seedbed, and other action that may be required to li/larklng. The process of designating the trees that are to be alter the site to accommodate new trees. sold and cut. A common practice is to spray indelible paint on Stumpage. Standing timber or, more generally, recoverable the tree at eye level and at ground level. This allows the wood in those trees that have not been severed from their buyer to identify the trees to be sold and the seller to deter- roots by cutting. Stumpage would therefore include the wood mine that only marked trees were cut. in trees that have been blown over or broken by wind or ice Material Participation. The act of participating in the storms. operations of a trade or business activity on a regular, Sublessor A lessee who leases a leasehold interest to a continuous, and substantial basis. third party. Net Operating Loss. The excess when total deductions for a Timber. taxpayer's trade or business activities exceed gross income Defíned.—For federal income tax purposes, timber for a particular tax year. generally means the wood in standing trees that is Net Present Value. The discounted present value of all available and suitable for exploitation and use by the revenues and all costs associated with an investment. forest industries. Section 631 of the Code broadens the Operating Costs. The ordinary and necessary costs associ- meaning to include certain evergreen trees cut and sold ated with the day-to-day operation and management of for ornamental purposes, see page 38. business and investment property. Trespass.—An unlawful taking of timber without the Proceeds. The total amount received from the disposition of permission of the owner. an asset, either as payment in cash, notes or other securities, Timeline. A diagram showing the year when costs are services in kind, or any other valuable consideration. incurred and income is received over the period of a timber Regulations. The interpretations by the Department of the investment. Treasury of the Federal tax laws (Code) enacted by the U.S. Transaction. An accounting term used to designate an action Congress. They provide the official rules for applying the or event that leads to an entry in the books of account. Code to the circumstances of specific taxpayers. Uniform Capitalization Rules. The rules that require that Revenue Rulings. The official interpretations by the Internal preproductive costs associated with a business or investment Revenue Service of the application of the Code, related be capitalized rather than expensed if the preproductive statutes, tax treaties, and Regulations to specific circum- period is more than two years. stances. They are published for the information and guidance Yield Tax. A state tax due when income is realized from of taxpayers, 1RS personnel, and other concerned. harvesting timber. It is usually levied in lieu of an ad valorem Salvage Sale. The sale of damaged timber before it deterio- tax that would othen/vise be due on the timber itself. rates to the point of worthlessness. Scaling. The process of measuring the dimensions of individual logs or trees. The measurements are used to

89 Appendix I. Summaries of Selected Revenue Rulings

Pertinent revenue rulings (Rev. Rul.) dealing with timber are components are depreciable or amortizable since all have a summarized below. Obsolete and inconsequential rulings are determinable useful life to the taxpayer. Rev. Rul. 88-99, not listed. Citations are given to the complete texts: Cumula- 1988-2 C.B. 33. tive Bulletin (C.B.) published by the U.S. Department of the Treasury. The rulings are categorized by general subject and Long-term contracts, royalties vs. rent—The fair market value listed alphabetically within each general subject by key word. of the timber existing at the time of the execution of a long-term timber purchase contract constitutes the basis for Basis and Depletion Ailowance depletion of the timber and payments in excess of the fair market value are consideration for the use of land deductible Christmas trees, capital and operating expenditures—In as a business expense. Amplified by Rev. Rul. 78-267. Treas. connection with the cultivation, as a trade or business, of Reg. §§1.162-1, 1.612-1. (Sees. 162, 612). Rev. Rul. Christmas trees for purposes of sale when they are more 75-59,1975-1 C.B. 177. than 6 years old, the expenditures incurred for planting, must be capitalized. Expenditures incurred for silvicultural practices "Purchaser credit" road construction contract. Forest Ser- such as weeding, cleaning, and noncommercial thinning are vice—^The basis for cost depletion of timber does not include deductible as ordinary and necessary trade or business the "purchaser credit" earned for specified road construction expenses. The cost of land improvements is capitalized in the under a Forest Service contract. Further, amounts expended land account. The cost of purchased equipment and other for construction of such roads are recovered through depre- depreciable assets, such as culverts and fences, should be ciation if the roads are used for harvesting the timber or capitalized and recovered through the allowance for depre- added to the depletion basis if the roads are not used for ciation. Modified by Rev. Rul. 71-228. Rev. RuL 66-18, harvesting the timber. Treas. Reg. §§1.611-5, 1.612-1, 1966-1 C.B. 59. 1.631-1. (Sees. 611. 612, 631). Rev. Rul. 71-354,1971-2 C.B. 246. Christmas trees, capital and operating expenditures—Costs incurred for shearing and basal pruning of trees grown for the Reforestation, replacing dead seedlings—A timber producer Christmas tree market are deductible business expenses. sustains no deductible loss on the death, not due to casualty, (Sec. 62). Rev. Rul. 66-18 modified. Rev. Rul. 71-228, of tree seedlings planted to reforest land from which it has 1971-1 C.B. 53. harvested the mature timber. Amounts paid or incurred in replanting to replace the lost seedlings must be capitalized in Cutting contract, advanced royalties—Advanced royalties accordance with reg. 1.611 -3(a). Modified by Rev. paid or accrued by a lessee under a timber cutting contract in Rul. 90-61. Treas. Reg. §§1.165-1, 1.611-3. (Sees. 165, 611). a tax year for timber cut during that year are not deductible Rev. Rul. 81-2,1981-1 C.B. 78. under the provisions of reg. 1.612-3(b)(3), but are to be added to the lessee's depletable basis in the timber. Treas. Reforestation—Generally, direct costs of reforestation Reg. §§1.612-3, 1.631-2. (Sees. 612, 631), Rev. Rul. 77-400, including girdling, herbicide application, baiting of rodents, 1977-2 C.B. 206. labor and tool expense, and the planting and seeding equipment depreciation are capital expenditures recoverable Logging roads, permanent vs. temporary, investment credit— through depletion allowances when the timber is cut or as A taxpayer's logging truck roads area "section 38 property" adjusted basis if the timber is sold. Indirect cost, deducted in for investment credit purpose since they are an integral part the year incurred or capitalized cumulatively under Section of the operation of sawmills, the production of lumber and 266, include interest paid on money borrowed or service related products, or the manufacture of paper. Distinguished charges on performance bonds in lieu thereof to satisfy a by Rev. Rul. 73-217. Treas. Reg. 1.46-3(e)(4),(5); State law requiring a deposit to guarantee reforestation. Rev. 1.46-3(c)(1); 1.48-1 (k); 1.48-1 (b)(4), 1.48-1(d)(2),(4). Rul. 55-252 superseded. Treas. Reg. §§1.263(a)-1, 1.611-3, (Sees. 38, 48). Rev. Rul. 68-281,1968-1 C.B. 22. 1.1011-1 (Sees. 263, 611, 1011). Rev. Rul. 75-467,1975-2 C.B. 93. Logging roads, depreciation—Depreciation of logging truck roads is distinguished in situations where (1) the road is Reforestation, payments under forestry incentives program— expected to be useful to the taxpayer for an indefinite period, The excludable portion of cost-sharing payments received and (2) the road has a determinable useful life to the tax- under the forestry incentives program (FIP) is excludable payer. In the first situation, where the surfacing, bridges, and from gross income, and the total costs of reforestation less culverts of a logging truck road are expected to have a the excludable portion are to be capitalized as a cost of determinable useful life to the taxpayer, these assets are timber. Under the election not to have Section 126 apply to depreciable or amortizable. Since the roadbed of a well- the FIP payment, the entire payment is ineludible in gross maintained road has an indefinite useful life, its cost is not income, and the total costs of reforestation (not reduced by depreciable or amortizable. In the second situation, all any portion of the FIP payment) are to be capitalized as a

91 cost of timber. Rev. Rul. 76-6 modified and superseded. Cutting contract, fair market value of timber caf—The terms Treas. Reg. §§1.61-1. 16A.126-1, 16A.126-2, 1.194-1. of a contract under which the taxpayer acquired the unre- 1.611-3. (Sees. 61. 126. 194. 611). Rev. Rul. 84-67,1984-1 stricted right to cut and use timber in its lumber manufactur- C.B. 28. ing business are not relevant in determining the fair market value of timber cut. Treas. Reg. §1.631-1. (Sec. 631). Rev. Reforestation expenditures—The expenditures for destroying Rul. 74-271,1974-1 C.B. 151. undesirable hardwood trees and brush in naturally reforested stands of southern pine young growth when related primarily Cutting contract, payment for failure to Cüí—Amounts to the seeding and establishment of the pine seedlings are received under a timber cutting contract for timber cut. the capital expenditures recoverable through depletion. Treas. quantity of which is based upon a "cruise" rather than scaling, Reg. §1.611-3. (Sec. 611). Rev. Rul. 76-290,1976-2 qualifies for treatment under Section 631(b). A penalty C.B. 188. payment received for failure to cut any portion of the "cruised" or marked trees during the term of the contract is ordinary Cost sliaring, payments under stewardship income. Treas. Reg. §1.631-2. (See. 631). Rev. Ruf. 78-104, incentive program—Vr^e stewardship incentive program (SIP) 1978-1 C.B. 194. was determined to be substantially similar to the enumerated programs in Section 126 of the Code. Thus, SIP cost-sharing Cutting contract, quantity first determined, holding period—A payments in connection with improvements in small water- taxpayer who acquired timber cutting rights under a USDA sheds may be eligible for exclusion from gross income under Forest Service cutting contract is considered to have first Section 126. (As a result, the excludable portion of these definitely determined the quantity of timber cut, for the cost-sharing payments is excludable from gross income, and purposes of the election to treat cutting of timber as a sale or the total costs of improvements less the excludable portion exchange, when a truck scale was made using a bureau are to be capitalized to the appropriate land or timber sealer at the time the logs arrived at the taxpayer's sawmill account.) Reg. §§1.61-1,16A.126-1, 16A.126-2. (Sees. 61, even though a mill deck scale was made later by a Forest 126). Rev. Rul. 94-27 1994-1 C.B. 26. Service sealer. Distinguished by Rev. Rul. 73-489. Treas. Reg. §1.631-1. (Sec. 631). Rev. Rul. 73-267,1973-1 Capital Gains C.B. 306.

Cutting contract, "contract right to cut" defined—To be entitled Cutting contract, quantity first determined, holding period—A to the benefits of Section 631 (a) of the Code as the holder of fiscal-year accrual method taxpayer who acquired timber a "contract right to cut" timber, a taxpayer must have acquired cutting rights under USDA Forest Service cutting contracts under such contract a proprietary interest in the timber which requiring that, for payment purposes, logs be sealed by a he cuts. Treas. Reg. §1.631-1 (Sec. 631). Rev. Rul. 58-295, Forest Service sealer and who elects to treat the cutting of 1958-1 C.B. 249. timber as a sale or exchange is considered to have cut the timber for purposes of section 631 (a) when the logs are Cutting contract, contract right to cut, future right—An option sealed on the mill deck by the Forest Service sealer in the on a right to cut timber that is transferred as part of an ordinary course of business. Distinguishing Rev. Rul. 73-267. exchange of property is not an enforceable contract right to Treas. Reg. §1.631-1. Rev. Rul. 73-489,1973-2 C.B. 208. cut for Section 631 (a) purposes, in cases where the claimed right to cut is exercisable only after a future date or occur- Default of performance bond—An amount received by the rence or is contingent upon an election or a transfer of fee-owner of certain timber lands from the default of a cash additional consideration by a taxpayer. The holding period in performance bond posted by a grantee under a contract such cases commences only when the right to cut becomes involving the cutting and disposal of timber is not an amount exercisable. Treas. Reg. §1.631-1. (Sec. 631). Rev. realized from the disposal of timber and is taxable as ordinary Rul. 74-529,1974-2 C.B. 185. income. Treas. Reg. §1.631-1. (See. 631). Rev. Rul. 61-56, 1961-1 C.B. 243. Contract cutting, road credit—The amount subject to treat- ment under Section 631 (b) by a corporate timberland owner Disposal, expenses for-—Expenditures directly attributable to that disposes of timber under a cutting contract that specifies a disposal of timber are reductions of the amount received for the unit price for an estimated number of units and the purposes of computing gain or loss from such disposal. amount of a "road credit" allowed the purchaser for building Whether expenditures are directly attributable to a disposal is access roads is the actual amount realized, which is the total determined on the strength or persuasiveness of each case contract price reduced by the road credit. Treas. Reg. and how closely related to the disposal the activities are in §1.631-2. (Sec. 631). Rev. Rul. 75-306,1975-2 C.B. 243. connection with the expenditures. Treas. Reg. §1.631-2. (Sec. 631). Rev. Rul. 71-334,1971-2 C.B. 248. Christmas trees sold on "choose and cut" basis—Income realized from the sale of Christmas trees that are selected Disposal, economic interest retained—\n the case of the and cut on the taxpayer's land by individual purchasers is disposal of timber, held for the requisite period of time prior to ordinary income. However, the taxpayer may elect to treat the disposal, by the owner thereof under any type of contract by cutting of trees as sales or exchanges of timber as prescribed virtue of which the owner retains an economic interest in such by reg. 1.631 -1. Treas. Reg. §§1.631 -1.1.1231 -1. timber, the amount received qualifies for capital gain treat- (Sees. 631.1231). Rev. Rul. 77-229,1977-2 C.B. 210. ment regardless of the nature of the taxpayer's business or

92 the purpose for which the timber is held. (Sec. 631,1231). trees and not to the sale of tree tops and limbs lying on the Rev. RuL 57-90,1957-1 C.B. 199. ground. Income from the sale of the tree tops and limbs is ordinary gain or loss; however, the Section 631 (a) benefits Holding period—A taxpayer who acquired timber on Decem- apply to the entire standing tree. The method of computing ber 31.1962. and still owned it at the beginning of his tax the fair market value of such trees is specified. (Sec. 631). year which began July 1. 1963, has owned such timber for a Rev. Rul. 56-434,1956-2 C.B. 334. period of more than 6 months before the beginning of such tax year for purposes of Section 631 (a). Treas. Right to cut and remove for landowner—A taxpayer who Reg. §1.631-1. (Sec. 631). Rev. Rul. 66-6,1966-1 C.B. 160. acquires by contract the right to cut, remove and sell timber from the land of another for the account of the landowner, but Holding period—A capital asset acquired on the last day of not the right to cut the timber for sale on his own account or any calendar month, regardless of whether the month has for use in his trade or business, is not the holder of "a 31 days, must not be disposed of until on or after the first day contract right to cut" for purposes of the election under of the seventh succeeding month of the calendar in order to Section 631 (a). Also, the taxpayer is not entitled to the have been "held for more than 6 months" within the meaning treatment provided by Section 631 (b), relating to a disposal of Sections 1222(3) and (4), and 1231. Rev. Rul. 66-7, by the owner. Treas. Reg. §1.631-1. (Sec. 631). Rev. 1966-1 C.B. 188. Rul 58-579,1958-2 C.B. 361.

Long-term contract, capital gains vs. ordinary /ncome—Under Timberland, sale of, used in trade or business—Gain realized a contract for a term of 60 years granting the right to grow by an electing small business corporation from the sale of timber and to cut timber growing and to be grown, a paper timberland held primarily for the production of timber products company was obligated to make yearly payments not and not for sale to customers is gain from the sale of real contingent on the quantities of timber cut. Held, the transac- property used in a trade or business under Section 1231(b) of tion is not a "disposal" of timber under Section 631 (b). the Code, subject to the provisions of Section 1.1375-1 (d) of Payments equal to the fair market value of the timber existing the regulations. Treas. Reg. §§1.231-1, 1.1375-1. at the execution of the contract are proceeds of a sale of (Sees. 1231, 1375.) Rev. Rul. 73-222,1973-1 C. B. 373. timber and any gain included in this amount is capital gains, provided the conditions of Sections 1221 or 1231 are met. When "cut"—For purposes of determining capital gain or loss, Any excess of such payments over the fair market value of timber is considered "cut" at the time when in the ordinary the timber existing at the execution of the contract is ordinary course of business the quantity of timber felled is first income. Amplified by Rev. Rul. 78-267. Treas. definitely determined, rather than at the time of the felling. Reg. §§1.631-1. 1.1221-1, 1.1231-1. (Sees. 631, 1221, Treas. Reg. §1.631-1, (Sec. 631). Rev. Rul. 58-135,1958-1 1231). Rev. Rul. 62-81,1962-1. C.B. 153. C.B. 519.

Long-term contract, unstated interest—The application of the Timberland tracts, deeds in escrow, holding period—The unstated interest provisions to long-term timber contracts is holding period of each of several tracts in a timber acreage described in situations in which the taxpayer is (1) a land- purchased under a single indivisible contract with annual owner who receives the entire consideration under the payments and release of deeds from escrow based on tracts contract in a lump sum on the date the contract is signed, selected for cutting begins on the day after the execution of (2) a landowner who is to receive payments over a period of the contract. Treas. Reg. §1.631-1. (Sec. 631). Rev. Rul. 60 years under a contract for the sale of timber and lease of 72-252,1972-1 C.B. 193. the land on which the timber is growing, and (3) a paper company that makes payments under a contract similar to Tree stumps, investment property—Income from the sale of that in situation 2. Rev Ruis. 62-81, 62-82 and 75-59 tree stumps by a timberland owner who is not in the business amplified. Treas. Reg. §§1.483-1. 1.1221-1, 1.1231-1. of buying or selling timber is taxable as a capital gain where (Sees. 483, 1221, 1231). Rev. Rul 78-267,1978-2 C.B. 171. the land was acquired in a cutover state as a real estate investment and the stumps were sold in one lot. (Sec. 1221). Long-term lease, lump sum payment—A lump sum payment Rev. Rul. 57-9,1957-1 C.B. 265. received under a contract for the lease of land and the grant of the right to cut timber therefrom constitutes proceeds of the Involuntary Conversions sale of timber to the extent of fair market value of the timber then existing. The resulting gain or loss is subject to the Casualty loss, deduction limited to basis—The allowable treatment described in Sections 1221 or 1231 provided the deduction for a casualty loss due to destruction of timber by conditions thereof are met. Any excess of such payments hurricane may not exceed the adjusted basis for determining over the fair market value of the existing timber is ordinary loss from the sale or other disposition of the quantity of timber income. Amplified by Rev Rul. 78-267. Treas. which by fair and reasonable estimates is found to be unfit for Reg. §§1.631-1, 1.1221-1, 1.1231-1. (Sees. 631, 1221, use because of the hurricane. Distinguished by Rev. 1231). Rev. Rul. 62-82.1962-1 C.B. 155. Rul. 87-59. Treas. Reg. §1.165-7 (Sec. 165). Rev. Rul. 66-9, 1966-1 C.B. 39. Pulpwood from tops and limbs of sawtimber frees—Treating the cutting of timber as the disposal of standing trees for Casualty loss, insect—The death of ornamental trees 5 to capital gain purposes applies only to the disposal of standing 10 days following a massive southern pine beetle attack in an

93 area not known for such massive attacks results in an Losses, timber in trees killed by insects—Loss of timber over allowable casualty loss deduction to the extent provided by a 9-month period following an unexpected and unusual insect Section 165(c). Modifies Rev. Rul. 57-599. Distinguished by attack that killed the timber trees gives rise to an allowable Rev. Rul. 87-59. Treas. Reg. §1.165-7 (Sec. 165). Rev. noncasualty business loss deduction that must be netted with Rul. 79-174,1979-1 C.B. 99. other noncasualty Section 1231 gains and tosses. Rev. Ruis. 66-9 and 79-174 distinguished. Amplified by Rev. Rul. 90-61. Casualty loss, partial damage—Ice storm damage to mer- Treas. Reg. §§1.165-1. 1.165-7. 1.611-3. 1.1231-1. chantable trees that reduces the rate of growth or quality of (Sees. 165. 611. 1231). Rev. Rul. 87-59,1987-2 C.B. 59. subsequent timber increment but does not render the existing timber unfit for use is not a deductible casualty loss. Treas. Losses, seedlings killed by drought—An unusual and Reg. §1.165-7 (Sec. 165). Rev. Rul. 73-51,1973-1 C.B. 75. unexpected drought that caused the death of tree seedlings planted for the commercial production of timber gives rise to Casualty loss, nonrecognithn of gain—The nonrecognition of an allowable noncasualty business loss deduction that must gain provisions of Section 1033(a) are applicable to the be netted with other noncasualty Section 1231 gains and proceeds received from the voluntary sale of timber downed losses. Rev. Rul. 81-2 distinguished, Rev. Rul. 87-59 ampli- by high winds, earthquake, or a volcanic eruption when the fied. Treas. Reg. §§1.48-1, 1.611-3.1.194-1.1.1231-1. (Sees. proceeds are used to purchase other standing timber. Rev. 48.165.194. 611 1231). Rev. Rul. 90-61,1990-2 C.B. 39. Rul. 72-372 revoked. Treas. Reg. §1.1033(a)-2 (Sec. 1033). Rev. Rul. 80-175,1980-2 C.B. 230.

94 Appendix II. Index and Findings Lists

PARTA: INDEX B

See findings lists for court case and revenue ruling refer- Basis ences. Adjusted "Sec." refers to section of the Internal Revenue Code Sec. 1011 "Regs." refers to section of Internal Revenue Regulations Sec. 1016 Relevant 1RS taxpayer publications are referred to in the text. Parker Tree Farm Ag. Handbook for allowable basis or depletion Powe Allocation Accounting Methods Reg. 1.611-3(d)(2) & (3) Generally Bratton Sec. 446 Drey (1960) Rev. Rul. 76-242 Powe Ag. Handbook Willamette (1980) Advanced Payments, Treatment of Ag. Handbook Regs. 1.612-3(b) Carryover Regs. 1.631-2(d) Sec. 1023 Rev. Rul. 77-400 Ag. Handbook Ag. Handbook Cost Advanced Royalties Sec. 1012 Capital V. Expense Ag. Handbook fair market value as Rev. Rul. 77-400 Sec. 631(a) Ad Valorem Taxes Regs. 1.631-1(d)(3) &(e) See "Capital v. Expense." "Taxes," Ag. Handbook Agricultural Conservation Program (ACP) Depletion Exclusion of cost-share payments See "Depletion Allowance" this Index See "Cost-Sharing Payments" this Index Full Recovery of Allocation of Cost Robinson See "Depletion Allowance" this Index Gift Allowable Basis Sec. 1015 See "Basis, adjusted" this Index Inherited Amortization Sec. 1014 Reforestation expenses Limitation of casualty loss deduction See "Reforestation Expenses" this Index See "Casualty Losses" this Index Annual Growth Year of Recovery As factor in determining depletion Broadhead(1966) Regs. 1.611-3(0) Block Accounting Belcher (1965) See "Depletion Allowance" this Index Bratton Bonus Depreciation Ag. Handbook See "Depreciation" this Index Ownership of Bonus Payments, Treatment of Union Bag-Camp Paper Corp. (1963) Regs. 1.612-3(a) Assignment of Cutting Contract Regs. 1.631-2(d)(3) As precluded later disposal Brush Control Pankratz See "Capital v. Expense" this Index Loss deduction Business v. Hobby J. R. Simplot Co. Generally Restriction of assignment effect of Sec. 183 Jantzer Sec. 212 Shaffer Regs. 1.183-1 Willamette Valley Lumber Co. Clark Attorney's Fees Clayton See "Capital v. Expense" this Index St.Germain Audits and Appeals Ag. Handbook Ag. Handbook Guidelines for determining profit motive Regs. 1.183-2

95 Business Losses Advanced royalties See "Losses-Business" this Index Rev. Rul. 77-400 Byproducts Attorney's fees See "Tops, Limbs. Chips and Stumps" and "Turpentine" this Anderson-Tully Index McMullan(1978) Warner Mountains Lumber Co. Brush control Rev. Rul. 66-18 Capital Asset 76-290 Defined Barham Sec. 1221 Chapman & Dewey (1964) Broadhead(1972) Ag. Handbook Everett Carrying charges Forbes See "Carrying Charges" this Index Huxford Christmas Tree Operation Norton Regs. 1.611-3(a) Ouderkirk Rev. Rul. 66-18 Powe 71-228 Ag. Handbook Kinley See also "Outright SaleCapital Gain v. Ordinary Income" this Ransburg Index Ag. Handbook Ownership of effect of prior disposal Cruising expenses Pankratz See "Timber cruise expenses" this heading Capital V. Expense Depreciation of equipment Generally See "Depreciation" this Index Regs. 1.611-3(a) Developmental expenses Regs. 1.631-1(e)(2) Rev. Rul. 75-405 Regs. 1.631-2(e)(1) Maple Form T [ft. note 3] Wagner Mills Rev. Rul. 55-252 Direct expense of disposal 58-266 Rev. Rul. 58-266 66-18 71-334 71-288 McMullan(1978) 71-334 Union Bag-Camp Paper Corp. (1963) 76-6 Ag. Handbook 76-290 Election to capitalize 77-400 See "Option to capitalize" this heading Barham Farms, orchards and ranches Belcher (1960) Rev. Rul. 75-405 Broadhead(1966) Maple Casey Peterson Chapman & Dewey (1964) Wagner Mills Converse Fire prevention expenses Drey Rev. Rul. 66-18 Kinley Warner Mountains Lumber Co. Maple Ag. Handbook McMullan(1978) Hardwood tree control McMullan(1982) See also "Brush control" this heading Ransburg Rev. Rul. 76-290 Regan Ag. Handbook Robinson Land & Lumber Co. Interest Union Bag-Camp Paper Corp (1963) Form T (Timber) Warner Mountains Lumber Co. [ft. note 3] Willamette Valley Lumber Co. Rev. Rul. 82-78 Ag. Handbook McMullan(1982) Ad Valorem taxes Warner Mountains Lumber Co. Form T (Timber) Ag. Handbook [ft. note 3] Land clearance expenses McMullan(1978) Regs. 1.182-2 Union Bag-Camp Paper Corp.(1963) Regs. 1.611-3(a) Warner Mountain Lumber Co. Rev. Rul. 55-252 Willamette Valley Lumber Co. 66-18

96 Peterson Drey (1982) Land management expenses McMullan(1978) McMullan(1982) Southern Pacific Union Bag-Camp Paper Corp. (1963) Union Bag-Camp Paper Corp. (1963) Ag. Handbook Warner Mountains Lumber Co. Logging Roads Wilmington Trust Co. See "Logging Roads" this Index Ag. Handbook Operating expenses Site preparation or improvement expenses McMullan(1982) Regs. 1.611-3(a) Peterson Form T (Timber) Ag. Handbook [ft. note 3] See "Carrying Charges" this Index Schedule E Option to capitalize Broadhead(1966) Form T (Timber) Chapman & Dewey [ft note 3] Ag. Handbook Rev. Rul. 55-252 Surveying Maple Wacker Planting expenses Taxes Form T (Timber) See "Ad valorem taxes" this heading [ft. note 3] Thinning costs Schedule E Rev. Rul. 66-18 Regs. 1.611-3(a) Barham Rev. Rul. 55-252 Chapman & Dewey 75-405 Ag. Handbook 76-6 Timber cruise expenses Chapman & Dewey (1964) Rev. Rul. 71-334 Maple Alabama Mineral Land Co. (1956) Wagner Mills Brown (1963) Ag. Handbook Robinson Land & Lumber Co. Pruning and shearing expenses Warner Mountains Lumber Co. See "Christmas trees" this Index Ag. Handbook Reforestation expenses Timber stand improvement See "Reforestation Expenses" this Index for amortization Generally provisions Ag. Handbook Form T (Timber) As a carrying charge [ft. note 3] Ag. Handbook Sch. E See "Carrying Charges" this Index Regs. 1.611-3(a) Capital Gains Rev. Rul. 55-252 Generally 75-467 Ag. Handbook 76-6 See specific type in this Index 76-290 Capital V. Ordinary Loss Belcher (1960) See "Losses" this Index Chapman & Dewey (1964) Capitalization Johnson (1991) See "Capital v. Expense" this Index Ag. Handbook Carrying Charges Reimbursement under forestry incentive program Generally See "Cost-Sharing Payments" thislndex Sec. 266 Rent Regs. 1.266-1 Regs. 1.631-2(c)(1) Parker Tree Farm Rev. Rul. 62-81 Warner Mountains Lumber Co. 62-82 Ag. Handbook 75-59 See also "Timber Stand Improvement" this Index Dyal Case Law McMullan(1978) Ag. Handbook Union Bag-Camp Paper Corp. (1963) Casualty Losses Union Bag-Camp Paper Corp. (1966) Generally Road construction costs Sec. 165 See "Logging Roads" this Index Regs. 1.165-7 Selling expenses Sec. 1231 Rev. Rul. 58-266 Regs. 1.1231 71-334

97 Rev. Rui. 66-9 Knapp 71-254 Squirt Co. 72-372 Fungi toss 73-51 Burns Alcoma Asscxîiation Coleman Belcher (1960) Maher Blomeley Martz Broadhead(1966) Oregon Mesabi Corp. Carloate Industries Hurricane & tornado Harper Rev. Rul. 66-9 Knapp 72-372 Krome 80-175 Miller Alcoma Association Nelson Bowers Oregon Mesabi Corp. Harper Rosenthal Krome Squirt Co. Zardo Ward Ice storm Weyerhaeuser Co. Rev. Rul. 73-51 Ag. Handbook Hale Basis limitation of deduction Laurie Rev. Rul. 66-9 Rosenthal 71-254 Insect Alcoma Association Rev. Rul. 79-174 Belcher (1960) Burns Blomeley Coleman Broadhead(1966) Cristo Carloate Industries McKean Harper Miller Knapp Nelson Rosenthal Oregon Mesabi Corp. Waldrip Waldrip Ward Land damage Westvaco Rev. Rul. 71-254 Ag. Handbook Broadhead(1966) Burden of proof Carloate Industries Blomeley Knapp Rosenthal Squirt Co. Capital gains set-off Logging roads Weyerhaeuser Co. Johnston Drought Method of computing loss Rev. Rul. 81-2 Sec. 165 Ruecker Regs. 1.165-7(a)(2)(1) Failure of proof Rev. Rul. 66-9 Harper 71-254 Rosenthal Alcoma Association Fire loss Blomeley Rev. Rul. 66-9 Bowers Belcher (1960) Carloate Industries Broadhead(1966) Knapp Cooper Krome Oregon Mesabi Corp. Rosenthal Ward Squirt Co. followed by insect attack and fungi damage Westvaco Oregon Mesabi Corp. Ag. Handbook Formula for computing loss Nonbusiness property See "Method for computing loss" this heading Regs. 1.165-7 Freeze loss Austin Rev. Rul. 66-9 Bowers 71-254 Burns Blomeley Forrest Carloate Industries Hale

98 Laurie Sec. 170 Mäher Conservation easements Martz Generally McKean Code 170(h) Nelson value of retained property Ruecker Drey (1982) Wald rip Exchanges of timberland with state Zardo Rev. Rul. 76-253 Partial destruction Timber for timberland Rev. Rul. 66-9 Rev. Rul. 76-253 71-254 77-148 Alcoma Association Rogers (1962) Broadhead(1966) Zemurray Harper Christmas Trees Knapp Generally Krome Ag. Handbook Rosenthal As timber (1986 Code) Westvaco Sec. 631(a) Ag. Handbook Regs. 1.631-1(b)(2) Pre-1958 tosses Regs. 1.631-2(e)(3) Weyerhaeuser Co. Beiike Pulpwood destroyed Schudel failure to prove basis Ag. Handbook Rosenthal Nottimber (1939 Code) Section 123 Vs effect Rev. Rul. 53-217 Ward "Choose and cut" sales Weyerhaeuser Co. Rev. Rul. 77-229 Ag. Handbook Expenses in Christmas tree operation Separate treatment of land and trees Regs. 1.611-3(3) Rev. Rul. 66-9 Rev. Rul. 66-18 71-254 71-228 Broadhead(1966) Kinley Carloate Industries Ransburg Squirt Co. Ag. Handbook Suddenness Fair market value, how determined Rev. Rul. 79-174 Schudel Austin Ag. Handbook Burns Shearing expenses Forrest Rev. Rul. 66-18 Miller 71-228 Nelson Kinley Suffocation Ransburg Miller Ag. Handbook Timber destroyed Condemnations Belcher (1960) Generally Broadhead(1966) Ag. Handbook Harper Conservation Easement Rosenthal See "Charitable Contribution" this Index Ward Conservation Reserve Program (CRP) Westvaco Generally Uninsured losses Ag. Handbook Weyerhaeuser Co. Contract Right to Cut v. Service Contract Value of remaining trees undiminished See "Cutting as a Sale or Exchange" this Index Harper Cost-Sharing Payments Year of deduction Excluded from income Oregon Mesabi Corp. Sec. 126 Young growth Regs. 16A.126 no deduction allowed Ag. Handbook Rosenthal Recapture Ward Sec. 1255 Charitable Contribution Regs. 16A. 1255 Generally Ag. Handbook

99 Taxable income when received Lansing Rev. Rul. 76-6 Wagar Lumber Co. Ag. Handbook effect of limitation on taxpayer's right to sell Court System Carlen Generally Ellison Ag. Handbook Lansing Crop Method of Accounting Shaffer Rev. Rul. 76-242 Stone Cruising Expenses Weyerhaeuser Co. See "Capital v. Expense" this Index effect of taxpayer's option to sell logs to grantor Cut-over Land, Sale of Johnson (1957) See "Outright sale - Capital Gain v. Ordinary Income" this effect of grantor's option to purchase logs Index Gilmore Cutting as a Sale or Exchange Shaffer Generally Stone Sec. 631(a) Wirkkala Regs. 1.631-1 exchange of Rev. Rul. 53-217 Everett 55-352 ownership contrasted 58-135 Weyerhaeuser Co. 56-434 proprietary interest requirement 58-295 Regs. 1.631-1(b)(1) 58-579 Rev. Rul. 58-295 60-244 58-579 61-57 Carlen 66-6 Carpenter 74-271 Ellison 74-529 Gilmore Allen Logging Johnson (1957) Beiike Lansing Cabax Mills Shaffer Carlen Stone Carpenter Varn Clemens Weyerhaeuser Co. Cornish Wirkkala Ellison service contract distinguished Gilmore Carlen Johnson (1957) Carpenter Kelsay Ellison Lansing Gilmore Martin Timber Johnson (1957) Murphy Lansing Pinkerton Shaffer Pope & Talbot Stone Schudel Wirkkala Shaffer Date of cutting Stone Regs. 1.631-1(a)(2) Varn Rev.Rul. 58-135 Wagar Lumber Co. 73-267 Weyerhaeuser Co. 73-489 Wirkkala Election, how made Ag. Handbook Regs. 1.631-1(0) Christmas Trees Beiike Schudel Cornish Ag. Handbook Ag. Handbook Contract right to cut date of acquiring Election by a partnership Allen Logging Beiike Buse Cornish Cabax Mills Examples of how section operates Carpenter Ag. Handbook Clemens Fair market value of timber cut Kelsay under election

100 as a cost of logs and timber products Lansing Sec. 631(a) Wagar Lumber Co. Regs. 1.631-1(d)(3) date of cutting Regs. 1.631-1(e) See "Date of cutting" this heading Longview Fibre Proprietary interest requirement Ag. Handbook See "Contract right to cut" this heading how determined Revocation of election, limitation on Regs. 1.611-3(f) Sec. 631(a) Regs. 1.631-1(d)(2) Regs. 1.631-1(a)(3) Rev. Rul. 74-271 Theft used as evidence of Bratton Watkins Bridges (1979) Who may make election Cascade Lumber Co. Sec. 631(a) Deer Park Pine Industries Regs. 1.631-1(b)(1) Draper Watkins Ellingson See also "Contract right to cut" this heading partnership Lysek Beiike Martin Timber Cornish Murphy Year of cutting Peek Regs. 1.631(a)(2) Poison Logging Co. Rev. Rul. 58-135 Pope & Talbot Cutting Contracts Schudel Assignment or sale of Willamette (1980) Rev. Rul. 77-247 Willamette (1981) Bridges (1979) Gain or loss, how computed Indian Creek Lumber Company timber cut under election Swartz Sec. 631(a) J.R. Simplot Co. Regs 1.631-1(d) Exchange of Pope & Talbot Evertt Pope & Talbot (Ct. App.) Long-term Ag. Handbook timber products resulting from cutting See "Lease v. cutting contract" this Sec. 631(a) Index Regs. 1.631-1(e) Outright sale-capital gain v. ordinary income Holding period generally Indian Creek Lumber Co. Sec. 631(a) Snider Regs. 1.631-1(a)(2) Valuation of Regs. 1.631-1(a)(4) See "Valuation" this Index Rev Rul. 55-352 58-135 61-57 66-6 Damage Awards 72-252 Severance 74-529 Drey (1982) Allen Logging Date of Acquiring Ownership/Contract Right to Cut Carpenter See "Ownership of Standing Timber" or "Cutting as a Sale Clemens or Exchange" this Index Cornish Date of Cutting Kelsay See "Cutting as a Sale or Exchange" this Index Lansing Date of Disposal Wagar Lumber Co. See "Disposal with a Retained Economic Interest" this Ag. Handbook Index date of acquiring ownership/contract right to cut Default on Performance Bond, Treatment of Amount Received Rev Rul. 74-529 Rev. Rul. 61-56 Allen Logging Depletion Allowance Barclay Generally Cabax Mills Sec. 611 Carpenter Sec. 612 Clemens Regs. 1.611-1 Giustina Regs. 1.611-3 Hitchcock Regs. 1.631-1(d) Kelsay Rev. Rul. 75-59

101 Ah Pah Redwood Co. Regs. 1.611-3(b) Belcher (1960) Ah Pah Redwood Co. Bratton Belcher (1960) Broadhead(1966) Bratton Broadhead(1972) Drey (1960) Drey (1960) Ag. Handbook Ag. Handbook Definitions relating to timber depletion economic interest Aggregating timber and land for purposes of valuation and Regs. 1.611-1(b) accounting Ag. Handbook fair market value Regs. 1.611-3(d)(1) Regs. 1.611-1 (d)(2) Allocation of cost between timber and land Regs. 1.611-3(f) Regs. 1.611-3(d)(2)&(3) Bratton Bratton Cascade Lumber Co. Drey (1960) Deer Park Pine Industries Willamette Industries (1980) Poison Logging Co. Ag. Handbook Ag. Handbook property See also "Basis, Allocation" this Index Regs. 1.611-1 (d)(1) Apportionment of depletion deduction among owners of Deposit forfeiture economic interests Lamm Lumber Co. Sec. 611(b) Fair market value, determination of Regs. 1.611-1(c) between lessor and lessee See "Definitions" this heading and "Cutting as a Sale or Sec. 611(b)(1) Exchange" this Index Regs. 1.611-1 (c)(2) between life tenant and remainderman revaluation not allowed Sec. 611(b)(2) Regs. 1.611-3(g) Regs 1.611-1 (c)(3) between trustee and income beneficiaries Form T (Timber) Sec. 611(b)(3) Regs. 1.611-3(h) Regs. 1.611-1(c)(4) between estate and heirs Reprint of form Sec. 611(b)(4) Growth factor Regs. 1.611-1 (c)(5) Regs. 1.611-3(e) Basis on which depletion allowed Belcher (1960) Sec. 612 Bratton Regs. 1.612-1 Immature timber account Rev. Rul. 71-354 Regs. 1.611-3(d)(3) 75-59 Bratton 76-6 Drey (1960) Ah Pah Redwood Co. Ag. Handbook Belcher (1960) Information to be furnished by the taxpayer Bratton Regs. 1.611-3(h) Broadhead(1966) Form T (Timber) Broadhead(1972) Quantity of timber, determination of Drey (1960) Regs. 1.611-3(e) retroactive adjustment not allowed Wilson Ah Pah Redwood Co. revision of estimate Ag. Handbook exhaustion of basis Regs. 1.611-3(e) Robinson Records to be filed by taxpayer Block accounting Regs. 1.611-3(h) Regs. 1.611-3(d)(1) Form T (Timber) to be kept by taxpayer Ag. Handbook Regs. 1.611-3(0) Bonus and advance payments, treatment of Ag. Handbook Regs. 1.612-3 Timber account, procedures for maintaining Regs. 1.631-2(d)(3) Regs. 1.611-3(d) Ag. Handbook Form T (Timber) Capital recoverable Powe Regs. 1.611-3(a) When depletion occurs Belcher (1960) Regs. 1.611-3(b)(1) Broadhead(1966) Rev. Rul. 58-135 Broadhead(1972) Broadhead(1966) Drey (1960) Broadhead(1972) Powe Ag. Handbook Robinson Who may take depletion deduction Computation of depletion deduction Regs. 1.611-1 (b) Sec. 611 Georgia-Pacific (1978) Sec. 612

102 Depreciation Lawton Generally Lowes Lumber Co. Sec. 48 Pankratz Ag. Handbook Plant Additional first year depreciation Ray Ownership of Schnitzer Union Bag-Camp Paper Corp. (1963) Springfield Plywood Corp. LaCroix Superior Pine Products Powars applicable only to tangible personal property Timber Conservation Co. Rev. Rul. 67-51 Union Bag-Camp Paper Corp (1963) LaCroix Varn Powars Wilson Equipment Wineberg Rev. Rul. 55-252 Ag. Handbook 66-18 Ad valorem taxes reimbursed Broadhead(1966) Giustina(1967) Chapman & Dewey (1964) Advanced payments, treatment of Converse Regs. 1.631-2(d) Union Bag-Camp Paper Corp. (1963) Goldbold Western Montana Lumber Co. Plant Ag. Handbook Ag. Handbook Improvements Amount realized Sec. 611 Rev. Rul. 75-306 Regs. 1.611-5 78-104 Logging roads Emmerson See "Logging Roads" this Index Basis recovery Direct Expense of Disposal Regs. 1.631-2 See "Capital v. Expense" this Index Broadhead (1966) Disposal With a Retained Economic Interest Bonus payments, treatment of Generally Regs. 1.631-2(d)(3) Sec. 631(b) Contract, necessity of Regs. 1.631-2 Sec. 631(b) Rev. Rul. 58-266 Regs. 1.631-2(a)(1) 57-90 Ah Pah Redwood Co. 58-579 Barclay 61-56 Belcher (1960) 62-81 Burroughs and Collins Co. 62-82 Forbes 75-59 Giustina(1962) 75-306 Hitchcock 77-247 Jantzer Ah Pah Redwood Co. Cutting rights disposal of Barclay Rev. Rul. 77-247 Belcher (1960) Pankratz Boeing (1951) Dyalwood retention of Broadhead (1966) Ray Brown Wood Preserving Co. Date of disposal Burroughs and Collins Co. Sec. 631(b) Camp Regs. 1.631-2(b). (c) Crosby Ah Pah Redwood Co. Dyal Giustina(1962) Dyalwood Hitchcock Emmerson Lowes Lumber Co. Forbes Pankratz Gammill Default on performance bond, treatment of amount Gaskins received Giustina(1962) Rev. Rul. 61-56 Giustina(1967) Direct expense of disposal Godbold See "Capital v. Expense" this Index Hitchcock Dividend treatment excess price on disposal to related Huxford taxpayer Jantzer Emmerson

103 Economic interest defined Hitchcock Regs. 1.611-1(b)(1) Jantzer Indian Creek Lumber Company Pankratz Godbold Springfield Plywood Corp. Plant Ag. Handbook Ag. Handbook effect of escalator clause date of acquiring ownership Huxford requirement that owner retain Barclay Sec. 631(b) Giustina(1962) Regs. 1.631-2(a)(1) Hitchcock Ah Pah Redwood Co. date of disposal Belcher (1960) See "Date of disposal" this heading Boeing (1951) Implied promise to cut Crosby Burroughs and Collins Co. Dyal Lowes Lumber Co. Giustina(1962) Lease of timberland v. disposal with retained economic Godbold interest Regs. 1.631-2(e)(1) Hitchcock Rev. Rul. 62-81 Huxford 62-82 Indian Creek Lumber Company 75-59 Jantzer Camp Lawton Dyal Plant Godbold Superior Pine Products Lawton Union Bag-Camp Paper Corp. (1963) Plant Varn Superior Pine Products Wilson Union Bag-Camp Paper Corp. (1963) Wineberg License to cut as a disposal Ag. Handbook risk of loss Ah Pah Redwood Co. Huxford Springfield Plywood Corp. Indian Creek Lumber Company Oral contract as a disposal Effect of cutting arrangement being terminable by mutual Ah Pah Redwood Co. consent Barclay Ah Pah Redwood Corp. Burroughs and Collins Co. Gaskins Dyalwood Wilson Forbes Effect of timber backlog provision Ordinary course of business, disposals in Crosby Regs. 1.631-2(a)(2) Godbold Rev. Rul. 57-90 Plant Ah Pah Redwood Co. Election to treat date of advance payment as date of Boeing disposal Sec. 631(b) Forbes Regs. 1.631-2(b). (c)(1) Varn Ag. Handbook manner of making election Ag. Handbook Regs. 1.631-2(c)(1) Owner defined Example of how section operates Sec. 631(b) Ag. Handbook Regs. 1.631-2(e)(2) Gain or loss, how computed Rev. Rul. 58-579 Sec. 631(b) 77-247 Regs. 1.631-2(a)(1). (2) Giustina(1962) Rev. Rul. 71-334 Hitchcock Ag. Handbook Indian Creek Lumber Company gain reduced by direct expense of disposal Jantzer Rev. Rul. 58-266 Schnitzer gain reduced by road credit Union Bag-Camp Paper Corp. (1963) Rev. Rul. 75-306 Varn Holding period Wilson Sec. 631(b) Ag. Handbook Regs 1.631-2(a)&(b) Payment in excess of value as a taxable dividend Ah Pah Redwood Co. Emmerson Barclay Stuchell Boeing (1951) Pre-arranged transfer of cutting rights Giustina(1962) Rev. Rul. 77-247

104 Reimbursement of ad valorem taxes Rev. Rul. 80-175 Giustina(1967) Ag. Handbook promise of future conveyance Related business entity, disposal to Starker (75) Rev. Rul. 77-247 Starker (77) Barclay Timber for timber Belcher (1965) Everett Emmerson Timber for timberland Georgia-Pacific (1978) Wineberg Georgia-Pacific (1981) Timberland for timberland Giustina(1962) Rev. Rul. 76-253 Hitchcock Starker (75) Lowes Lumber Co. Starker (77) Wilson dividend treatment of excess payments Timberland for right to cut timber Emmerson Oregon Lumber Co. Reservation of security title, effect of Expense v. Capital Timber Conservation Co. See "Capital v. Expense" this Index Retention of cutting rights, effect of Ray Varn Timber defined Fair Market Value of Timber Brown Wood Preserving Co. See "Valuation" this Index Ag. Handbook Farming Status Christmas trees are (1986 Code) Generally Sec. 631 (a) Ag. Handbook Regs. 1.631-1(b)(2) Business losses Regs. 1.631-2(e)(3) tops and limbs Regs. 1.270-1 (b)(2) Rev. Rul. 56-434 turpentine is not Clayton Brown Wood Preserving Co. St.Germain Volume cut how determined Clearing land Rev. Rul. 78-104 Regs. 1.182-2 Drought Excess deductions account See "Casualty Losses," this Index Peterson Soil and water conservation expenditures Regs. 1.175-3 Regs. 1.175-4(a)(2) Economic Interest Straughn As precluding outright sale Ag. Handbook Forbes Fire Ray Losses due to See also "Disposal with a Retained Economic Interest" this Ag. Handbook Index See also " Casulaty Losses" this Index Elections by Taxpayer Prevention expenses To capitalize expenses Ag. Handbook See "Capital v. Expense" this Index See "Capital v. Expense" this Index To treat a cutting as a sale or exchange Forest Service Timber See "Cutting as a Sale or Exchange" this Index See "Public Timber" this Index To treat date of advance payment as date of disposal Forestation Expenses See "Disposal with a Retained Economic Interest" this See "Reforestation Expenses" this Index Index Forestry Incentive Payments (FIP) Equipment See "Cost-Sharing Payments" this Index Depreciation Forfeiture of Deposit on Timber Sale See "Depreciation Deduction" this Index Contracts Sale of Lamm Lumber Co. Converse Forms Kirby Lumber Corp. (1950) Form 4797 Equitable Ownership Ag. Handbook See "Reservation of Security Title" this Index Schedule D Evergreen Trees Defined Ag. Handbook See "Christmas Trees, as timber" this Index T (Timber) Exchanges Regs. 1.611-3(h) Like-kind Ag. Handbook Sec. 1031

105 Wagar Lumber Co. Ag. Handbook Gain or Loss Cutting as a sale or exchange Generally See "Cutting as a Sale or Exchange" this Index Sec. 1001 disposal with a retained economic interest Ag. Handbook See "Disposal with a Retained Economic Interest" this See also "Sales, Types of" this Index Index From Sec. 126 Property outright sale Sec. 1255 See "Outright Sale" this Index Regs. 16A. 1255 Ag. Handbook I How computed Ag. Handbook Improvements, Depreciation of When reported Generally Ag Handbook Sec. 611 See also "Cutting as a Sale or Exchange" or "Disposal with Regs. 1.611-5 Appendix IV. Forms for Recording Timber Transactions a Ag. Handbook Retained Economic Interest" this Index Indians Gifts, Basis of Exemption from tax See "Basis" this Index Capoeman Gift to Charity Kirschling See "Charitable Contributions" this Index Purchases from Growth, Accounting for Barclay Ag. Handbook Hitchcock See also "Basis" this Index Wagar Lumber Co. Insurance H Proceeds from Ag. Handbook Hardwood Tree Control Installment Sales See "Capital v. Expense" this Index Sec. 453 Hobby V. Business Rev. Rul. 82-78 See "Business v. Hobby" this Index Ag. Handbook Hobby Expenses, How to Recover Interest Ag. Handbook See "Capital v. Expense" this Index Holding Period Inventory Method of Accounting Generally See "Accounting Methods" this Index Sec. 631(a) Investment Credit Sec. 631(b) Generally Sec. 1231(a) Sec. 46 Sec. 1231(b) Reforestation Regs. 1.631-1(a)(2), (4) See "Reforestation Expenses" this Index Regs. 1.631-1(b)(1) Logging roads Regs. 1.631-2(a)(1) Rev. Rul. 68-281 Regs. 1.631-2(b) Nonrecognition of gain Rev. Rul. 55-352 Rev. Rul. 72-372 58-135 80-175 61-57 Investment Property 66-6 Capital gains treatment 66-7 Sec. 1221 Ah Pah Redwood Co. Ag. Handbook Barclay Expenses Boeing (1951) Ag. Handbook Bridges (1979) Involuntary Conversions Carpenter Sec. 1033 Clemens Ag. Handbook Cornish See also "Casulaty Losses" this Index Giustina(1962) Hitchcock Lansing Lowes Lumber Co. Joint Ventures Pankratz Created by timber lease Springfield Plywood Co. McMullan(1982)

106 Robinson timber license Land Clearing Los Angeles Shipbuilding See "Capital v. Expense" and "Farming Status" this Index Business losses Land Management Expenses Regs. 1.270-1 (b)(2) See "Capital v. Expense" this Index Clark Lease v. Cutting Contract St.Germain Generally does not reduce Sec. 631 (a) Regs. 1.631-2(e)(1) gain Rev. Rul. 62-81 Foster Lumber Co. (Sup. Ct.) 62-82 KDI Navcor 75-59 Pope and Talbot Camp Capital V. ordinary Dyal purchase price discount Lawton Smith Superior Pine Products transfer of contract Union Bag-Camp Paper Corp. (1963) J.R. Simplot Co. Union Bag-Camp Paper Corp. (1966) carryback of net operating losses Fair market value of timber, how determined Foster Lumber Co. Bridges (1979) KDI Navcor See also "Cutting as a Sale or Exchange" this Index Casualty losses Interest See "Casualty Losses" this Index Rev. Rul. 78-267 Forfeiture of deposit on timber sale contract License v. Sale Lamm Lumber Co. Jantzer Involuntary conversion Lowes Lumber Co. Rev. Rul. 72-372 Springfield Plywood Co. Passive activity Like-Kind Exchanges See "Passive Activities" this Index See "Exchanges" this Index Sale to related business entity Liquidation of Timber Holdings McGrew Capital Gain v. Ordinary Income Broadhead (1966) M Consolidated Naval Stores Co. Mines Management Expenses Huxford See "Capital v. Expense - Land management expense" this Kirby Lumber Co. (1969) Index Three States Lumber Co. Material Participation Logging Roads Generally Generally Ag. Handbook Casey See also "Passive Activities" this Index Converse Minimum Tax (Alternative) on Tax Preferences Regan Generally Ag. Handbook Sees. 55-58 Depreciation of Ag. Handbook Rev. Rul. 68-281 88-99 Investment credit Rev. Rul. 68-281 Operating Expenses Public timber See "Capital v. Expense" this Index Rev. Rul. 71-354 Operating Losses Purchase credit See "Losses" this Index Rev. Rul. 71-354 Options 75-306 Grantor's right of first refusal, effect of Road use fees as capital gain Gilmore Watts as deductible expense Shaffer Watts as ordinary income Stone Wineberg Wirkkala Losses To capitalize Abandonment Form T (Timber) Assignment of contract [ft. note 3] J.R. Simplot Co. Rev. Rul. 55-252 cutting rights Ag. Handbook

107 To cut Ray Rev. Rul. 74-529 Equipment Kelsay Converse Ordinary Income Kirby Lumber Corp. (1950) From sales of cut forest products Factors to be considered Ag. Handbook Forbes timber Huxford Ag. Handbook McMullan(1982) Qualification for self-employment tax Powe Ag. Handbook Scott Outright Sale-Capital Gain v. Ordinary Income Snider Generally Ag. Handbook Sec. 1221 Holding Period Sec. 1231(b)(1)(B) Rev. Rul. 66-7 Regs. 1.1231-1(c)(1) Ag. Handbook Rev. Rul. 57-9 Liquidation of timber holdings 66-7 Broadhead(1966) 73-222 Consolidated Naval Stores Co. Alabama Mineral Land Co. (1956) Huxford Belcher (1960) Kirby Lumber Corp. (1969) Belcher (1965) Three States Lumber Co. Broadhead(1966) Netting of gains and and losses Broadhead(1972) Ouderkirk Camp Mfg. Co. Nursery stock Consolidated Naval Stores Co. Tesche Converse "Primarily for sale" discussed Crosby Broadhead (1966) Gammill Broadhead(1972) Huxford Forbes Jordan Huxford Kirby Lumber Corp. (1950) Powe Kirby Lumber Corp. (1969) Scott Malat Snider McMullan(1982) Ag. Handbook Norton Property purchased for resale Ouderkirk Crosby Peebles Grammill Reese Snider Rutland Property used in trade or business Scott Sec. 1231(b) Snider Norton Superior Pine Products Ouderkirk Tesche Sale to related business entity Three States Lumber Co. Belcher (1960) Willey Belcher (1965) Wineberg Crosby Ag. Handbook Stumps Culled trees (tree nursery) Rev. Rul. 57-9 Tesche Huxford Cut-over timberland Jordan Consolidated Naval Stores Co. Timber Ouderkirk Belcher (1960) Reese Belcher (1965) Three States Lumber Co. Camp. Mfg. Co. Cutting contracts Crosby Snider Gammill Norton Huxford Disposals with a retained ecomomic interest Kirby Lumber Corp. (1950) See "Disposals with a Retained Economic Interest" this Kirby Lumber Corp. (1969) Index Peebles Economic interest, retention of precluding outright sale Powe Forbes Rutland

108 Wineberg Murphy Timber contracts Effect of prior disposal Snider Pankratz Norton Effect of pre-arranged transfer Timberland Rev. Rul. 77-247 Rev. Rul. 73-222 Factual question Broadhead(1966) Lowes Lumber Co. Broadhead(1972) Local law Consolidated Naval Stores Co. Allen Logging Kirby Lumber Corp. (1950) Wilson Reese Proprietary interest requirement Scott Rev. Rul. 77-247 Three State Lumber Co. Varn Owner Defined not necessary for "ownership" under Section 631(a) See "Disposal with a Retained Economic Interest and Weyerhaeuser Co. "Cutting as a Sale or Exchange" this Index necessary for "ownership" under Ownership of Standing Timber Section 631(b) Generally Rev. Rul. 77-247 Sec. 631(b) Schnitzer Regs. 1.631-2(e)(2) Varn Rev. Rul. 58-579 1939 and 1986 Code provisions compared 77-247 Jantzer Allen Logging Wilson Barclay Cabax Mills Carlen Clemens Partial Destruction of Timber Gilmore Salvage necessary Giustina(1962) Ag. Handbook Hitchcock See also "Casualty Losses" this Index Jantzer Partnership Lowes Lumber Co. Sales to partner Murphy Hitchcock Pankratz McGrew Union Bag-Camp Paper Corp. (1963) Passive Activities Varn Generally Weyerhaeuser Co. Sec. 469 Willamette Valley Lumber Co. Regs. 1.469-1 Wilson 1000 Friends of Oregon Wirkkala Ag. Handbook See also "Contract Right to Cut" this Index Activity defined Annual growth, ownership of Ag. Handbook Union Bag-Camp Paper Corp. (1963) Limits on deduction of losses Conditional vendee as owner Ag. Handbook Barclay Material participation Gilmore Ag. Handbook Giustina(1962) Personal Use, Property Held for Hitchcock Generally Willamette Valley Lumber Co. Ag. Handbook Wilson Plantation Account Date of acquiring ownership/contract right to cut For reforestation expenses Allen Logging Ag. Handbook Barclay See also "Depletion Allowance, immature timber account" Cabax Mills this Index Carpenter Planting Expenses Clemens See "Capital v Expense" and "Depletion Allowance" this Giustina(1962) Index Hitchcock Portfolio Income Lansing See "Passive Activities" this Index Wagar Lumber Co. Preproductive Period Effect of agreement to resell timber to the grantor of Generally timberlands See "Carrying Charges" this Index

109 Timber Stand Improvement Recapture See "Capital v. Expense, Timber stand improvement" this Sec. 1245(b)(8) Index Reg. 1.1245-4(h) Primarily for Sale, Timber Held for Ag. Handbook See "Disposal with a Retained Economic Interest" this Requirement to capitalize Index Johnson (1991) Private Foundations Ag. Handbook See "Taxes, Excise, private foundation" this Index Reimbursement Profit, How Defined Ad valorem taxes For timber investments and businesses [need to add Giustina(1967) cases] Ag. Handbook Rent Property Taxes See "Capital v. Expense" this Index See "Taxes, Ad Valorem" this Index Replacement Property Property Used in Trade or Business See "Involuntary Conversions" this Index Capital gains v. ordinary income Reservation of Security Title Sec. 1231(b) Effect on "disposal" Norton Timber Conservation Co. Ouderkirk Effect on "ownership" Ag. Handbook Barclay Proprietary Interest Requirement Gilmore See "Cutting as a Sale or Exchange this Index Giustina(1962) Pruning and Shearing Expenses Hitchcock See "Christmas trees" this Index Willamette Valley Lumber Co. Public Timber Wilson Holding period Restriction on Right to Assign Cutting Contract, Effect of Clemens See "Assignment of Cutting Contract, this Index Purchaser credit (roads) Restriction on Right to Sell Rev. Rul. 71-354 See "Cutting as a Sale or Exchage" this Index 75-306 Retained Economic Interest Purchaser Credit (Roads) See "Disposal with a Retained Economic Interest" this See "Public Timber" this Index Index Revocation of Section 631(a) Election See "Cutting as a Sale or Exchange" this Index Roads Quantity of Timber, How Determined See "Logging Roads" this Index For depletion or allowable basis Ag. Handbook See also "Depletion Allowance" this Index For cut timber subject to 631 (a) election Sale V. License Ag. Handbook Jantzer See also "Cutting as Sale or Exchange"this Index Lowes Lumber Co. Springfield Plywood Corp. Sales, Types of Defined Records Ag. Handbook To be filed by taxpayer Disposal on the Stump Regs. 1.611-3(h) Ag. Handbook Form T (Timber) See also "Outright SaleCapital Gain v. Ordinary Income" Ag. Handbook this Index To be kept by taxpayer Pay-as-cut contract Regs. 1.611-3(0) Ag. Handbook Reforestation Expenses See also "Diposal With a Retained Economic Interest" this See also "Capital v. Expense" this Index Index Amortization Products cut from timber Sec. 194 Ag. Handbook Reg. 1.194-1 to-4 See also "Cutting as a Sale or Exchange" this Index News Release 80-130 (See Int. Rev. Bulletin) Salvage of Damaged Timber Ag. Handbook Required for casualty loss determination Investment credit Ag. Handbook Sec. 48(a)(1)(F) See also "Casualty Losses" this Index Reg. 1.48-1 (b),(p) Scaling of Logs Ag. Handbook See "Quantity of Timber. Determination of" this Index

110 Selling Expenses individuals See "Capital v. Expense" this Index Sec. 55 Self Employment. Net Earnings From corporations Independent contractor Sec.55 Walker Stevenson Co-Ply, Inc. Timber gain or loss Theft Sec. 1402(a)(3)(b) See "Losses, Theft" this Index Regs. 1.402(a)-6(a) Thinning Expenses Ag. Handbook See "Capital v. expenses thinning" this Index Severance Damages Timber Accounts, Procedures for Maintaining See "Damage Awards" this Index Regs. 1.611-3(d) Shearing of Christmas Trees Form T (Timber) See "Christmas Trees" this Index Ag. Handbook Site Preparation or Improvement Expenses See also "Records" this Index See "Capital v. Expense" this Index Timber, Defined Soil and Water Conservation Expenditures Christmas tree as See "Farming Status" this Index Ag. Handbook Source of Income See also "Christmas trees" this Index Within or without the U.S., timber proceeds Other products as Regs. 1.863-1 (b) Ag. Handbook Special Use Value See also "Tops, Limbs, Chips and Stumps" this Index Sec. 2032A Timber Cruise Expenses As basis for assets See "Capital v. Expense" this Index Ag. Handbook Timber Stand Improvement (TSI) State Timber Taxation Generally Property taxes Ag. Handbook See "Taxes, Ad Valorem" this Index See also "Capital v. Expense, Timber stand improvement" Severance taxes and "Carrying Charges" this Index See "Taxes, Ad Valorem" this Index Tops, Limbs, Chips and Stumps Yield taxes Regs. 1.631-2(e)(3) See "Taxes, Ad Valorem" this Index Rev. Rul. 56-434 Stumpage Ag. Handbook See "Sales, Types of" this Index Travel Expenses Stumps, Sales of Deduction of Rev. Rul. 57-9 Ag. Handbook Jordan Tree Farming See also "Tops, Limbs, Chips and Stumps" this Index See "Business v. Hobby" and "Farming Status" this Index Turpentine Not timber Brown Wood Preserving Co. Taxes Ad valorem taxes U capital V. expense Union Bag-Camp Paper Corp. (1963) Unrelated Business Income of Exempt Organization, Timber reimbursement for Proceeds as Giustina(1967) Sec. 512(b)(5) Capital gain Regs. 1.512(b)-1(d) Sec. 1202 Sec. 1255 Corporate Sec. 1201 Young Growth Estate taxes Account See also "Estate Planning and Taxation" this Index Ag. Handbook Excise See also "Depletion Allowance" this Index Private foundation Losses of Balso Foundation Ag. Handbook Zemurray Foundation See also "Casualty Losses, Premerchantable timber" this Gift Index Kirschling See also "Estate Planning" this Index Alternative minimum tax See "Minimum Tax" this Index Valuation Fair market value of nonbusiness property

111 Cristo Alcoma Assoc. Inc. v. United States Hale 56-2 USTC 119612. 51 AFTR 1037 (S.D. Fla. 1956) Zardo 239 F2d 365. 57-1 USTC 1(9203. 50 AFTR 1172 (5th Cir. Fair market value of stock 1956)(rev'g) restricted Brownell Allen Logging & Veneer Co. v. United States Fair market value of timber 73-2 USTJ 119691. 32 AFTR2d 73-5310 (W.D. Wash. 1973) defined Regs. 1.611-1 (d)(2) Anderson-Tully Company and Subsidary v. Commissioner Regs. 1.611-3(f) Tax Ct. Mem. Dec. (CCH) 41.314(M). (P-H) 1184.338 (1984) Regs. 1.631-1(d)(2) Bratton Austin V. Commissioner Cascade Lumber Co. Tax Ct. Rep. (CCH) 37.258. (P-H) 1174.98(1980) Deer Park Pine Industries Martin Timber Barclay v. United States Poison Logging Co. 333 R2d 847. 166 Ct. CI. 421. 64-2 USTC 19547. Willamette (1981) 13AFTR2d 1706 (1964) Ag. Handbook how determined Barham v. United States Regs. 1.611-3(f) 301 R Supp. 43. 69-1 USTC 119356, 23 AFTR2d 1347 (CD. Regs. 1.631-1(d)(2) Ga. 1969) Bratton 429 R2d 40, 70-2 USTC 119522, 26 AFTR2d 70-5173 Bridges (1969) (5th Cir. 1970) (aff'g percuriam) Cascade Lumber Co. Deer Park Pine Industries Belike v. Commissioner Draper 22 TC.M. 13, Tax Ct. Mem. Dec. (CCH) 25,906(M), (P-H) Ellingson 1163,005(1963) Lysek Murphy Belcher v. Commissioner Peek 24 TC.M. 1, Tax Ct. Mem. Dec.(CCH) 27.199(M), (P-H) Poison & Logging Co. 1165,001 (1965) Pope & Talbot Rogers (1983) Belcher v. Patterson Schudel 60-2 USTC 119733, 6 AFTR2d 5697 (N.D. Ala. 1960) Stuchell 302 R2d 289. 62-1 USTC 1|9426, 9 AFTR2d 1316 (5th Cir. Willamette Industries (1979) 1962) (rev'g and aff'g) Willamette Industries (1980) 305 R2d 557. 62-2 USTC 119585, 10 AFTR2d 5067 (5th Cir. Willamette Industries (1981) 1962) (denying reh'g) Fair market value of timberland 371 U.S. 921, 83 S.Ct. 289, 9 L.Ed.2d 230 (1962) (denying how determined cert.) Rev. Proc. 79-24 (See Int. Rev. Bulletin) 63-2 USTC 119678, 12 AFTR2d 5179 (N.D. Ala. 1963) Drey(1982) (rem'g sub. nom. Abernathy v. Patterson) Hipp Taylor, Exr. Blomeley v. Commissioner 23 TC.M. 514, Tax Ct. Mem. Dec.(CCH) 26,724(M), (P-H) Part B: Findings Lists 1164,084(1964)

COURT CASES Boeing v. United States 98 RSupp. 581, 121 Ct. CI. 9, 51-2 USTC 119411, 40 ARTR Ah Pah Redwood Company v. Commissioner 1104(1951) 26 TC. 1197, Tax Ct. Rep. (CCH) 21,952, (P-H) 111126.149 (1956) Bowers v. Commissioner 251 R2d 163, 58-1 USTC 119153, 1 AFTR2d 456 (9th Cir. Tax Ct. Mem. Dec. (CCH) 38,422(M), (P-H) 1181,658 (1981) 1957) (rev'g in part and rem'g) 18 TC.M. 202, Tax Ct. Mem. Dec. (CCH) 23,486(M). (P-H) Bratton v. Rountree 1159,044 (on rem'd) 37 AFTR2d 76-762 (CD. Tenn.1976)

Alabama Mineral Land Company (1939 Coda) Bridges v. United States 15 TC.M. 124. Tax Ct. Mem. Dec. (CCH) 21.557(M). (P-H) 70-1 USTC 1112,663. 25 AFTR2d 70-1495 (M.D. Fla. 1969) 1156.026(1956) 250 R2d 870, 58-1 USTC 119162. 1 AFTR2d 468 (5th Cir. Bridges v. Commissioner 1957) (rev'g in part and rem'g) 64 TC. 968. Tax Ct. Rep. (CCH) 33.401. (P-H) 1164.92 (1975). acq. 1976-2 C.B. 1 112 Bridges v. Commissioner Carlen v. Commissioner 38 T.C.M. 1126. Tax Ct. Mem Dec. (CCH) 36.208(M). (P-H) 20 TC. 573. Tax Ct. Rep. (CCH) 19.708. (P-H) 120.77 1179,290 (1979) (1953) 220 R2d 338. 55-1 USTC 19296.47 AFTR 322 (9th Cir. Broadhead, Estate of v. Commissioner 1955) (aff'g) 25 T.C.M. 133. Tax Ct. Mem. Dec.(CCH) 27.834(M), (P-H) 1166.026(1966) Carloate industries, inc. v. UnKed States 391 F.2d 841. 68-1 USTC 119249. 21 AFTR2d 851 (5th Cir. 230 R Supp. 282. 64-2 USTC 19564.14 AFTR2d 5327 1968)(afi'g) (S.D.Tex. 1964) 354 R2d 814. 66-1 USTC 19159.17 AFTR2d 059 (5th Cir Broadliead, Estate of v. Commissioner 1966) (rev'g and rem'g in part, aff'g in part) 31 T.C.M. 951. Tax Ct. Mem. Dec.(CCH) 31.531 (M). (P-H) 1172,195(1972) Carpenter v. Commissioner 32TC.M. 1047. Tax Ct. Mem. Dec. (CCH) 32.170(M). 36 TC. 797. Tax Ct. Rep. (CCH) 24,960, (P-H) 136.79 (P-H) 1173,222 (1973) (1961). acq. 1962-1 C.B. 3

Brown v. Commissioner Cascade Lumber Co. v. Squire 40 T.C. 861. Tax Ct. Rep. (CCH) 26,260. (P-H) 140.92 57-2 USTC 19841. 52 AFTR 1290 (W.D. Wash. 1957) (1963) Casey v. United States Brown Wood Preserving Co. v. United States 459 F2d 495. 198_ Ct.Ci. 232. 72-1 USTC 19419. 29 58-2 USTC 19604. 2 AFTR2d 5013 (W.D. Ky. 1958) AFTR2d 72-1089 (1972) 275 F.2d 525. 60-1 USTC 19316. 5 AFTR2d 953 (6th Cir. 1960) (rev'g and rem'g) Cfiapman & Dewey Lumber Co. v. United States 238 F Supp. 869. 65-1 USTC 19129.15 AFTR2d 070 (W.D. Browneli, Est. of v. Commissioner Tenn. 1964) 44TC.M. 1550, Tax Ct. Mem. Dec. (CCH) 39,459(M), 359 R2d 495. 66-1 USTC 19385. 17 AFTR2d 899 (6th Cir. (P-H) 182.632 (1982) 1966) (vac'g and rem'g per curiam)

Burns v. United States Ciarle V. Commissioner 174 F. Supp. 203. 59-2 USTC 19514. 3 AFTR2d 1520 (N.D. 28 TC.M. 1260, Tax Ct. Mem. Dec.(CCH) 29,831 (M), (P-H) Ohio 1959) 169.241(1969) 284 F.2d 436. 61-1 USTC 19127. 6 AFTR2d 6036 (6th Cir. 1960) Clayton v. Commissioner 65 TC.M. 2371, Tax Ct. Mem. Dec. (CCH) 48.978(M). Burrougiis & Collins Co. v. United States Apr. 1993 68-1 USTC 19389. 21 AFTR2d 1423 (D.S.C. 1968) Clemens v. United States Buse V. Commissioner 295 RSupp. 1339. 68-2 USTC 19620. 23 AFTR2d 69-326 71 TC. 1129. Tax Ct. Rep. (CCH) 35.966. (P-H)171.99 (D. Or. 1968) (1979), acq. 1980-1 C.B.I 439 F2d 705. 71-1 USTC 19258. 27 AFTR2d 71-834 (9th Cir. 1971) (aff'g) Cabax Mills v. Commissioner 59 TC. 401, Tax Ct. Rep. (CCH) 31,631. (P-H) 159.38 Coleman v. Commissioner (1972), acq. 1973-2 C.B. 1 76 TC. 580. Tax Ct. Rep. (CCH) 37.815. (P-H) 176.49 (1981). app.. 9-24-81 (6th Cir.) Camp V. United States 74-2 USTC 119596. 9597, 9598, 34 AFTR2d 74-5575, ' Consolidated Naval Stores Co. v. Falls 74-5573. 74-5571 (CD. Fla. 1974) 54-2 USTC 19456. 48 AFTR 1233 (S.D. Fla. 1954) 227 R2d 923. 56-1 USTC 19132, 48 AFTR 717 (5th Cir. Camp Manufacturing Co. v. Commissioner 1955) (rev'g) 3 TC. 467 (1944). acq. 1944 C.B. 4 Converse v. Earle Capoeman v. United States 51-2 USTC 19430, 43 AFTR 1308 (D. Or. 1951) 110 R Supp. 924, 53-1 USTC 19119. 43 AFTR 606 (W.D. Wash. 1952) Cooper v. Commissioner 220 R2d 349. 55-1 USTC 19295. 47 AFTR 329 (9th Cir. 42 TC.M. 418, Tax Ct. Mem. Dec.8,064(M). (P-H) 181.369 1955)(aff'gpercuriam) (1981) (app'l dismissed, 7th Cir.) 351 U.S. 1. 76 S. Ct. 611. 100 L Ed. 883.56-1 USTC 19474. 49 AFTR 178 (1956). 1956-1 C.B. 605 (aff'g)

113 Cornish v. United States Forrest v. Commissioner 221 F.Supp. 658. 63-2 USTC119662.12 Ain'R2d 5526 45 TC.M. 1156. Tax Ct. Mem. Dec. (CCH) 40.006(M), (D. Or. 1963) (P-H)183.177 (1983) 348 F.2d 175. 65-2 USTC 119508. 16 AFTR2d 5022 (9th Cir. 1965) (rev'g on other grounds and rem'g) Foster Lumber Co. v. United States 500 F2d 1230. 74-2 USTC 19611. 34 AFTR2d 74-5584 Cristo V. Commissioner (8th Cir. 1974) 44T.C.M. 1057, Tax Ct. Mem. Dec. (CCH) 39.326(1^1). 429 U.S. 32. 97 S.Ct. 204. 50 L.Ed.2d 199. 76-2 USTC (P-H) 1182.514 (1982) 19740.38 AFTR2d 76-6024 (1976), 1976-2 C.B. 72 (rev'g)

Crosby v. United States Gammili v. Commissioner 292 F.Supp. 314. 68-2 USTC 1|9571. 22 AFTR2d 5554 62 TC. 607. Tax Ct. Rep. (CCH) 32.722. (P-H) 62.60 (S.D. I^iss. 1968) (1974) 414 F2d 822, 69-2 USTC ^9514, 24 AFTR2d 69-5098 (5th Cir. 1969) (aff'g) Gasl(ins v. United States 67-2 USTC 19662. 20 AFTR2d 5144 (CD. Ga. 1966) Deer Parit Pine industry, inc. v. Squire 381 R2d 729, 67-2 USTC 19663, 20 AFTR2d 5577 (5th Cir. 60-2 USTC 119608, 6 AFTR2d 5349,5899 (W.D. Wash. 1967) (aff'g per curiam) 1960) Georgia-Pacific Corp. v. United States Draper v. United States 78-2 USTC 19811. 43 AFTR2d 79-337 (D. Or. 1978) 60-1 USTC 19284, 5 AFTR2d 842 (E.D. Wash. 1960) 648 R2d 653. 81-2 USTC 19515, 48 AFTR2d 81-5484 (9th Cir. 1981) (aff'g) Drey v. United States 61-1 USTC 119116. 7AFTR2d 333 (E.D. Mo. 1960) Gilmore v. United States 180 R Supp. 354. 149 Ct. CI. 54, 60-1 USTC 19259. Drey v. United States 5AFTR2d 685 (1960) 535 F.Supp. 287. 82-2 USTC 19422. 49 AFTR2d 82-1386 (E.D. Mo. 1982) Giustina v. United States 705 F.2d 965. 83-1 USTC 19219, 51 AFTR2d 83-769 190 RSupp. 303, 61-1 USTC 19169, 7 AFTR2d 381 (D. Or. (8th Cir. 1983),(affg). (Cert, denied 10-3-83) 1960) 313 R2d 710, 63-1 USTC 19145. 11 AFTR2d 307 (9th Cir. Dyai V. United States 1962) (vac'g and rem'g. aff'g in part) 64-1 USTC 19196.13 AFTR2d 446 (S.D. Ga. 1963) 342 F2d 248. 65-1 USTC 19285. 15 AFTR2d 490 (5th Cir. Giustina v. United States 1965) (rev'g and rem'g in part, aff'g in part) 267 RSupp. 40. 67-1 USTC 19313, 19 AFTR2d 1013 (D. Or. 1967) Dyaiwood, inc. v. United States 588 R2d 467, 79-1 USTC 19172, 43 AFTR2d 79-571 Godboid V. Commissioner (5th Cir. 1979) (aff'g unreported, 5th Cir.) 82 TC. 73, Tax Ct. Rep. (CCH) 40,918. (P-H) 182.7 (1984)

Eliingson Timber Co. v. Commissioner Hale V. Commissioner 36 TC.M. 809, Tax Ct. Mem. Dec. (CCH) 34,478(M),(P-H) 44 TC.M. 1117. Tax Ct. Mem. Dec. (CCH) 39,339(M), (P-H) 177.197(1977) 182.527(1982)

Eliison V. Franl( Harper v. United States 56-2 USTC 19760.19763, 51 AFTR 1423 (W.D. Wash. 274 R Supp. 809. 67-2 USTC 19712. 20 ARTR2d 5777 1956) (D.S.C. 1967) 245 R2d 837, 57-2 USTC 19748. 51 AFTR 807 (9th Cir. 396 R2d 223. 68-2 USTC 19441. 21 AFTR2d 1417 (4th Cir. 1957) (aff'g) 1968)

Emmerson v. Commissioner Hines V. United States 44 TC. 86. Tax Ct. Rep. Dec. (CCH) 27.352. (P-H) 144.8 344 R Supp. 1259. 72-2 USTC 19511, 30 AFrR2d 72-5037 (1965) (N.D. Miss. 1972) 477 R2d 1063. 73-1 USTC 19403. 31 AFTR2d 73-1215 Everett v. Commissioner (5th Cir. 1973) (rev'g) 37 TC.M. 274. Tax Ct. Mem. Dec. (CCH) 34.969(M).(P-H) 178,053(1978) Hitchcoci( V. Frani( 63-1 USTC 19497.11 AFTR2d 1703 (W.D. Wash. 1963) Forbes v. United States 75-1 USTC 19126.35 AFTR2d 75-448 (E.D. Tenn. 1974)

114 Huxford V. Unltsd States Krome v. Commissioner 299 F. Supp. 218, 69-2 USTC 119439,23 AFrR2d 69-1339 9 TC.M. 178, Tax Ct. Mem. Dec. (CCH) 17,543(M), (P-H) (N.D. Fla. 1969) 150,064(1950) 441 F.2d 1371, 71-1 USTC 1|9379, 27 AFTR2d 71-1298 (5th Cir. 1971) (affg) LaCroix v. Commissioner 61 TC. 471, Tax Ct. Rep. (CCH) 32,416, (P-H) 161.53 Indian CraaK Lumbar Co. v. Commlaslonar (1974) 43 T.C.M. 841, Tax a Mem. Dec. (CCH) 38,877(M), (P-H) 1182,146(1982) Lamm Lumber Co. v. Commissioner 45 B.TA. 1 (1941), acq. 1942-1 C.B.I 0, nonacq. 1942-1 Jantzer v. Commissioner C B 25 32 TC. 161, Tax Ct. Rep. (CCH) 23,549, (P-H) 1132.13 133 F.2d 433, 43-1 USTC 19286, 30 AFTR 918 (9th Cir. (1959) 1943) (aff'g) 284 F.2d 348, 60-2 USTC 119802, 6 AFTR2d 5882 (9th Cir. 1960)(aff'g) Lansing v. Commissioner 23 TC.M. 498, Tax Ct. Mem. Dec. (CCH) 26,721 (M). (P-H) Johnson v. United States 164,082(1964) 57-2 USTC 19848, 52 AFTR 1484 (W.D. Wash. 1957) 257 F.2d 530, 58-2 USTC 119725, 2 AFTR2d 5376 (9th Cir. Laurie v. Commissioner 1958)(aff'g) 41 TC.M. 1482, Tax Ct. Mem. Dec. (CCH) 37,904(M), (P-H) 181,239 (1981) Johnson v. Commissioner 62 TC.M. 46, Tax Ct. Mem. Dec. (CCH) 47,441 (M) (1991 ) Lawton, Estate of v. Commissioner 33 TC. 47, Tax Ct. Rep. (CCH) 23,795, (P-H) 133.6 (1959) Johnston v. Commissioner 41 TC.M. 258, Tax Ct. Mem. Dec. (CCH) 37,361 (M),(P-H) Longvlew Fibre v. Commissioner 1180,477(1980) 71 TC. 357, Tax Ct. Rep. (CCH) 35.570, (P-H) 171.33 51 AFTR2d 83-313 (9th Cir.) (aff'g) (1978)

Jordan v. United States Los Angeles Shipbuilding & Drydock Corp. v. United States 62-1 USTC 119370, 9 AFTR2d 1359 (S.D. Ala. 1962) 166 R Supp. 914. 58-2 USTC 19893, 2 AFTR2d 6068 (S.D. Cal. 1958) KDI Navcor, Inc. v. Commissioner 289 F.2d 222. 61-1 USTC 19329, 7 AFTR2d 984 (9th Cir. 35 TC.M. 341. Tax Ct. Mem. Dec. (CCH) 33.711 (M), (P-H) 1961) (vac'g on other grounds and rem'g) 1176.077(1976) A.F. Lowes Lumber Co. v. Commissioner Kelsay v. Commissioner 19 TC.M. 727. Tax Ct. Mem. Dec.(CCH) 24.268(M). (P-H) 31 TC.M. 1232. Tax Ct. Mem. Dec. (CCH) 31.642(M). 160.141 (1960) (P-H) 1172.249 (1972) Lysek v. Commissioner KIniey v. Commissioner 34 TC.M. 1267. Tax Ct. Mem. Dec. (CCH) 33.431 (M). 51 TC. 1000. Tax Ct. Rep. (CCH) 29.503. (P-H) 1151.102 (P-H) 175.293 (1975) (1969), acq. 1971-2 C.B. 3 583 R2d 1088. 78-2 USTC 19792 (9th Cir. 1978)(aff'g) 70-2 USTC 119462. 26 AFTR2d 70-5127 (2d Cir. 1970) (aff'g) Maher v. Commissioner 76 TC. 593. Tax Ct. Rep. (CCH) 37.816. (P-H) 176.50 Kirby Lumber Corp. v. Phinney (1981) 68-2 USTC 119446. 22 AFTR2d 5069 (W.D. Tex. 1968) 680 R2d 91. 82-2 USTC 19460. 50 AFTR2d 82-5290 412 F.2d 598. 69-1 USTC 119429, 23 AFTR2d 69-1528 (11th Cir. 1982) (aff'g) (5th Cir. 1969) (aff'g) Malat V. Ridden Kirby Lumber Corp. v. Scofield 64-1 USTC 19432,13 AFTR2d 1348 (S.D. Cal. 1964) 89 R Supp. 102. 50-1 USTC 119176. 39 AFTR 240 (W.D. 347 F.2d 23. 65-2 USTC 19452.15 AFTR2d 1121 (9th Cir. Tex. 1950) 1965) (aff'g) 383 U.S. 569. 86 S. Ct. 1030.16 L. Ed. 2d 102. KIrschling v. United States 1966-1 C.B. 184. 66-1 USTC 19317. 17 AFTR2d 604 82-1 USTC 1113.443. 49 AFTR2d 82-1455 (W.D. Wash. (1966) (vac'g and rem'g) 1981) 275 R Supp. 358, 66-2 USTC 19564,18 AFTR2d 5015 (S.D. Cai. 1966) (on remand) Knapp V. Commissioner 23 TC. 716. Tax Ct. Rep. (CCH) 20.832. (P-H) 123.93 (1955). acq. 1966-1 C.B. 2

115 Maple V. Commissioner Pankratz v. Commissioner 27T.C.M. 944. Tax Ct. Mem. Dec.(CCH) 29,115(M). (P-H) 22 TC. 1298, Tax Ct. Rep. (CCH) 20,579, (P-H) 122.162 168,194(1968) (1954) 440 F.2d 1055, 71-1 USTC 119348,27 AFTR2d 71-1144 (9thCir. 1971)(aff'g) Peebles v. Commissioner 5 TC. 14 (1945), acq. 1945 C.B. 6 Martin Timber Co. v. Commissioner 31 TC.M. 1266, Tax Ct. Mem.Dec. (CCH) 31,650(M), (P-H) Peek V. Commissioner 1172,255(1972) 45 TC.M. 1382, Tax Ct. Mem. Dec. (CCH) 40,063(M)

Martz V. Commissioner Peterson v. Commissioner 41 TC.M. 1236, Tax Ct. Mem. Dec. (CCH) 37,818(M),(P-H) 29 TC.M. 802, Tax Ct. Mem. Dec. (CCH) 30,217(M), (P-H) 1181,168(1981) 170,181 (1970)

McGrew v. Commissioner Pinkerton v. Commissioner 24 TC.M. 1391, Tax Ct. Mem.Dec. (CCH) 27,567(M), (P-H) 28 TC. 910, Tax Ct. Rep. (CCH) 22,496, (P-H) 128.101 1165,256 (1965) (1957). acq. 1958-1 C.B. 5

McKean v. Commissioner Plant V. United States 42 TC.M. 1709, Tax Ct. Mem. Dec. (CCH) 38,441 (M),(P-H) 81-2 USTC 19661. 48 AFTR2d 81-5936 (N.D. Ala. 1981) 1181.670(1981) 682 F2d 914. 82-2 USTC 19522. 50 AFTR2d 82-5505. (11 Cir. 1982) (aff'g) (Cert, den'y 4-18-83) McMullan v. United States 78-2 USTC 19656, 42 AFTR2d 78-5723 (1978) Poison Logging Co. v. Commissioner 12 TC.M. 664. Tax Ct. Mem. Dec.(CCH) 19.733(M). (P-H) McMullan v. United States 153.208 (1953) 686 F.2d 915, 82-2 USTC 119539, 13,483. 50 Afn"R2d 82-5494. 82-6199 (Ct. Cl. 1982) Pope & Talbot, Inc. v. Commissioner 60 TC. 74. Tax Ct. Rep. (CCH) 31.924. (P-H) 160.9 (1973) Miller V. Commissioner 515 F2d 155, 75-1 USTC 19424. 35 AFTR2d 75-1378 29 TC.M. 741. Tax Ct. Mem. Dec.(CCH) 30.196(M). (P-H) (9th Cir. 1975) (aff'g percuriam) 170.167(1970) Powars V. United States Murphy v. United States 285 FSupp. 72. 68-2 USTC 19562. 22 AFTR2d 5666 (CD. 60-1 USTC 119275. 9246. 5 Ain"R2d 784 (W.D. Wash. Cal. 1968) 1960) Powe V. Commissioner Nelson v. Commissioner 44 TC.M. 933. Tax Ct. Mem. Dec. (CCH) 39,293(M).(P-H) 27 TC.M. 158. Tax Ct. Mem. Dec.(CCH) 28.861 (M). (P-H) 182,488 168,035(1968) Ransburg v. United States Norton v. United States 281 FSupp. 324. 67-2 USTC 19672. 21 AFTR2d 560 (S.D. 551 F.2d 821, 213 Ct. CI. 215, 77-1 USTC 19296, Ind. 1967) 39 AFTR2d 77-1000 (1977) 43 U.S. 831. 98 S.Ct. 115. 54 L Ed.2d 91 (1977)(denying Ray V. Commissioner cert.) 32 TC. 1244, Tax Ct. Rep. Dec. 23,762, (P-H) 132.121 (1959) 1000 Friends of Oregon v. McPherson 283 F2d 337, 60-2 USTC 19739, 6 AFTR2d 5696 (5th Cir. 89-1 USTC 9217. 63 AFTR2d 89-563 (D. Oreg. 1988) 1960) (aff'g per curiam)

Oregon Lumber Co. v. Commissioner Reese v. Commissioner 20 TC. 192, Tax Ct. Rep. (CCH) 19.614. (P-H) 120.23 13 TC.M. 823, Tax Ct. Mem. Dec. (CCH) 20,518(M), (P-H) (1953). acq. 1953-2 C.B. 5 154,134(1954)

Oregon Mesabi Corp. v. Commissioner Regan v. United States 2 TC.M. 475. Tax Ct. Mem. Dec. (CCH) 13.385(M). (P-H) 67-2 USTC 19728. 20 AFTR2d 5759 (D. Or. 1967) 143,356(1943) 410 F2d 744. 69-1 USTC 19369. 23 AFTR2d 69-1460 (9th Cir. 1969) (rev'g) Ouderkirk v. Commissioner 396 U.S. 834. 90 S.Ct. 91. 24 L.Ed.2d 85 (1969) (denying 36 TC.M. 526, Tax Ct. Mem. Dec. (CCH) 34,376(M), (P-H) cert.) 177.120(1977)

116 Robinson v. Commissioner Smith V. Commissioner 12T.C. 246 (1949) 48 TC. 872, Tax Q. Rep. (CCH) 28,605, (P-H) 148.83 181 F.2d 17. 50-1 USTJ 119269. 39 AFTR 197 {5th Cir. (1967) 1950)(affg) 11 TTJ 129, 424 R2d 219, 70-1 USTC K9327, 25 AFTR2d 70-936 (9th Cir. 1970) (aff'g m part and rev'g) Robinson Land & Lumber Co. v. United States 112 F.Supp. 33.53-1 UST01|9364, 43 AITR 1012 (S.D. Smithgall v. United States Ala. 1953) 81-1 USTC 19121,47 AFTR2d 81-695 (N.D. Ga. 1980) (app'i not auth (G)) Rogers v. Commissioner 38 TO. 785, Tax Ct. Rep. (COH) 25.638. (P-H) 1138.78 Snider v. Commissioner (1962), nonacq. 1963-2 C.B. 6 34 TC.M. 530, Tax a. Mem. Dec. (CCH) 33,156(M). (P-H) 175.111(1975) Rogers v. Commissioner 46 T.G.M. 789, Tax Ct. t/lem. Dec. (CCH) 40.290(M). (P-H) Southern Pacific Transportation Co. v. Commissioner 1(83,420(1983) 75 TC. 497. Tax Ct. Rep. (CCH) 37.600. (P-H) 75.44 (1980) Rosenthai v. Commissioner 4 TTJ 167, digest 11 TTJ 156.48 TC. 515, Tax Ct. Rep. Springfield Plywood Corp. v. Commissioner (CCH) 28,533. (P-H) 1(48.50 (1967) 15 TC. 697, Tax Ct. Rep. (CCH) 17,946, (P-H) 115.91 6 TTJ 201. digest 11 TTJ 156,416 F.2d 491, 69-1 USTC (1950) K9430,23 AI=TR2d 69-1496 (2d Cir. 1969) (aff'g) Squirt Co. v. Commissioner Rueclter v. Commissioner 51 TC. 543, Tax Ct. Rep. (CCH) 29,401. (P-H) 151.53 41 T.C.IWI. 1587. Tax Ct. Mem. Dec. (CCH) 37,931 (M). (1969) (P-H) 1181.257 (1981) 423 F2d 710. 70-1 USTC 19281, 25 AFTR2d 70-842 (9th Cir. 1970) (aff'g) Rutland V. Tomllnson 63-1 USTC K9173,11 AFTR2d 500 (CD. Fla. 1962) Starlcer v. United States 327 F2d 668, 64-1 USTC K9267. 13 AFTR2d 744 (5th Cir. 75-1 USTC 19443, 35 AFTR2d 75-1550 (D. Or. 1975) 1964) (aff'g per curiam) Starlcer v. United States StGermain v. Commissioner 432 RSupp. 864, 77-2 USTC 19512,40 AFTR2d 77-5460 18 TC.M. 355, Tax Ct. IViem. Dec.(CCH) 23.547(1^1). (P-H) (D. Or. 1977), acq. I.R.B. 1982-28.5 K59,073 (1959) 602 R2d 1341. 79-2 USTC 19541,44 AFTR2d 79-5525 (9th Cir. 1979) (aff'g in part, rev'g in part and Schnitzer v. Unites States rem'g) 69-1 USTC K9160, 22 AFTR2d 5972 (D. Or. 1968) Stevenson Co-Piy, Inc. v. Commissioner Schudel V. Commissioner 76 TC. 637. Tax Ct. Rep. (CCH) 37,850. (P-H) 176.54 33 TC.M. 1155, Tax Ct. Mem. Dec. (CCH) 32.799(M). (1981). acq. I.R.B. 1982-28.5 (P-H)K74.262(1974) 563 R2d 1300, 77-2 USTC 1(9746, 40 AFTR2d 77-6139 Stone V. Granqulst (9th Cir. 1977) (rev'g and rem'g) 60-1 USTC 19148. 5 AFTR2d 304 (D. Or. 1959)

Scott V. United States Straughn, Estate of v. Commissioner 305 F.2d 460,158 Ct. CI. 434, 62-2 USTC K9617, 55 TC. 21, Tax Ct. Rep. (CCH) 30,367, (P-H) 155.4 (1970). 10AFTR2d 5173(1962) acq. 1976-2 C.B. 3

Shaffer v. Commissioner Stucheil V. Commissioner 19 TC.M. 978. Tax Ct. Dec. (CCH) 24.339(M), (P-H) 37 TC.M. 1017, Tax Ct. Mem. Dec. (CCH) 35.234(M). 1(60,185(1960) (P-H) 178,236 (1978)

Sherrod v. Commissioner Superior Pine Products Co. v. United States 82 TC. 523, Tax Ct. Rep. (CCH) 41,084, (P-H) K82.40 201 Ct. CI. 455. 73-1 USTC 19348. 31 AFTR2d 73-1134 (1984) (1973) (adopting Ct. Cl. Commissioner's Report) 414 U.S. 857. 94 S.Ct. 162. 38 L.Ed.2d 107 (1973) J. R. Simpiot Co. V. Commissioner (denying cert.) 26 TC.M. 488, Tax Ct. Mem. Dec.(CCH)28,458(M), (P-H) K67.104(1967)

117 Tasche v. Commissioner Watts V. Erickson 33 T.C. 122, Tax Ct. Rep. Dec.{CCH) 23,809, (P-H) 1133.14 62-2 USTC 19778.10 AFTR2d 5832 (D. Or. 1962) (1959). acq. 1960-2 C.B. 7 Western Montana Lumber Co. v. Commissioner Tliree States Lumber Co. v. Commissioner 20 TC.M. 1687. Tax Ct. Mem. Dec. (CCH) 25,156(M), 4T.C.M. 955. Tax Ct. Mem. Dec.(CCH) 14.815(M). (P-H) (P-H) 161.326 (1961) 1145.311(1945) 158 F.2d 61. 46-2 USTC 119398. 35 AFTR2d 357 (7th Cir. Westvaco Corporation v. United States 1946)(rev'g) 639 F.2d 700. 81-1 USTC 19101. 47 AFTR2d 406 (Ct. Ci. 1980) (No cert. (G)) Timber Conservation Co. v. United States 208 F.Supp. 626, 62-2 USTC 119578.10 Ain"R2d 5036 Weyerhaeuser Co. v. United States (D. Or. 1962) 66-1 USTC 19417,17 AFTR2d 893 (W.D. Wash. 1966) 402 R2d 620. 68-2 USTC 19629. 22 AFTR2d 5825 (9th Cir. Union Bag-Camp Paper Corp. v. United States 1968) (aff'g in part and rev'g in part) 325 F.2d 730. 163 Ct. CI. 525. 64-1 USTC 119122, 12AFTR2d 6127 (1963) Willamette Industries v. United States 79-2 USTC 19520, 44 AFTR2d 79-5321 (D. Or. 1979), aff'd Union Bag-Camp Paper Corp. v. United States by court order. 3-27-80 (9th Cir.) 366 F2d 1011. 177 Ct.CI. 212. 66-2 USTC 19694, 18AFTR2d 5758 (1966) Willamette Industries v. Commissioner 41 TC.M. 629. Tax Ct. Mem. Dec. (CCH) 37.514(M), (P-H) Varn, Inc. v. United States 180.577(1980) 425 F2d 1231. 70-1 USTC 119406, 25 AFTR2d 70-1201 (1970) (adopting Ct.CI. Commissioner's Report) Willamette industries, inc. v. United States 530 RSupp. 904, 81-2 USTC 19633, 48 AFTR2d 81-6045 Waci(er v. Commissioner (D. Or. 1981) 40 TC.M. 1009. Tax Ct. Mem. Dec. (CCH) 37.166(M). 689 R2d 865, 82-2 USTC 19625. 50 AFTR2d 82-5991. (P-H) 1180.324(1980) (9th Cir. 1982) (aff'g) (Cert, den'y 3-22-83)

Wagar Lumber Co. v. United States Willamette Valley Lumber Co. v. United States 181 RSupp. 388. 60-1 USTC 19343.5 AFTR2d 840 (W.D. 252 F.Supp 199. 66-1 USTC 19258. 17 AFTR2d 418 Wash. 1960) (D.Ore. 1966)

Wagar Mills, Inc. v. Commissioner Willey v. Commissioner 33 TC.M. 1267. Tax Ct. Mem. Dec. (CCH) 32,817(M), 9 TC.M. 1109. Tax Ct. Mem. Dec. (CCH) 18,011(M). (P-H) (P-H) 174.274(1974) 150,299(1950) 530 R2d 827. 76-1 USTC 19298, 37 AFTR2d 76-1018 10 TC.M. 267, Tax Ct. Mem. Dec. (CCH) 18.202(M). (8th Cir. 1976) (affg) (P-H) 151.072 (1951) (supplemental memorandum findings of fact and opinion) Waldrip v. United States 199 R2d 375, 52-2 USTC 19517 (6th Cir. 1952) (affg per 81-2 USTC 19653. 48 AFTR2d 81-6031 (N.D. Ga. 1981) curiam)

Walker v. Commissioner Wilmington Trust Co. v. United States 101 TC. 36. Tax Ct. Rep. Dec. (CCH) 49.460 (1993) 79-1 USTC 19223. 43 AFTR2d 78-801 (1979) (Ct. Cl.Trial Judge Op. 1979) (modified) Ward V. United States 610 R2d 703, 79-2 USTC 19707, 45 AFrR2d 80-301, 428 F2d 1288, 192 Ct. CI. 710, 70-2 USTC 19518. (1979) 26AFTR2d 70-5138 (1970) 400 U.S. 1008, 91 S.Ct. 567, 27 L Ed. 2d 621 (1971) Wilson V. Commissioner (denying cert.) 26 TC. 474 (1956), nonacq. 1962-2 C.B. 7

Warner Mountains Lumber Co. v. Commissioner Wineberg v. Commissioner 9 T.C. 1171 (1947). acq. 1948-2 C.B. 4 20 TC.M. 1715. Tax Ct. Mem. Dec. (CCH) 25,172(M). (P-H) 161.336(1961) Waticins, adv. United States 326 R2d 157, 64-1 USTC 19156, 13 AFTR2d 323 (9th Cir. 600 R2d 201. 79-2 USTC 19548. 44 AFTR2d 79-5222 1963) (aff'g) (9th Cir. 1979) (affg) 444 U.S. 871. 100 S.Ct. 148, 62 L.Ed.2d 96 (1979) Wirkkala v. United States (denying cert.) 181 RSupp. 338. 60-1 USTC 19344. 5 ARTR2d 837 (W.D.Wash.)

118 Zardo v. Commissioner 72-372; 1972-2 C.B. 471; revoked by: Rev. Rul. 80-175 43 T.C.IWI. 626. Tax Ct. iVlem. Dec. (CCH). 38,813(1^4). (P-H) 73-51; 1973-1 C.B. 75 182,094(1982) 73-222;1973-1 C.B. 373 509 F.Supp.976, 81-1 USTC 19419, 47 AFTR2d 81-1488 73-267; 1973-1 C.B. 306; distinguished by: Rev. Rul. 73-489 (E.D. La. 1981) 73-489; 1973-2 C.B. 208; distinguishing: Rev. Rul. 73-267 687 F.2d 97. 82-2 USTC 19609, 50 AI=TR2d 82-5786 74-271; 1974-1 C.B. 151 (5th Cir. 1982). (rev'g and rem'g) 74-529; 1974-2 C.B. 185 84-1 USTC 19246. 53 AFTR2d 84-842 (1984) (D.C. La.) on 75-59; 1975-1 C.B. 177; amplified by Rev. Rul. 78-267 rem. 75-306; 1975-2 C.B. 243 75-405; 1975-2 C.B. 63 75-467; 1975-2 C.B. 93; superseding: Rev. Rul. 55-252 REVENUE RULINGS 76-6; 1976-1 C.B. 176; superseded by Rev. Rul. 84-67 ("C.B." referes to 1RS Cumulative Bulletins) 76-242; 1976-1 C.B. 132; revoked by: Rev. Rul. 79-102; revoking i.T 1368 & O.D. 995; modified by: Rev. Rul. 77-64 53-217; 1953-2 C.B. 12 obsolete: Rev. Rui. 72-620 76-253; 1976-2 C.B. 51 55-252; 1955-1 C.B. 319; superseded by Rev. Rul. 75-467 76-290; 1976-2 C.B. 188 55-352; 1955-1 C.B. 372; obsolete: Rev. Rul. 76-566 77-64; 1977-1 C.B. 136; revoked by: Rev. Rul. 79-102 56-434; 1956-2 C.B. 334 77-148; 1977-1 C.B. 63 57-9; 957-1 C.B. 265 77-103; 1977-1 C.B. 273 57-90; 1957-1 C.B. 199 77-229; 1977-2 C.B. 210; corrected by Ann. 77-140 I.R.B. 58-135; 1958-1 C.B. 519 1977-39,52 58-266; 1958-1 C.B. 520 77-247; 1977-2 C.B. 211 58-295; 1958-1 C.B. 249 77-400; 1977-2 C.B. 206 58-579; 1958-2 C.B. 361 78-104; 1978-1 C.B. 194 60-244; 1960-2 C.B. 167 78-264; 1978-2 C.B. 9 61-56; 1961-1 C.B. 243 78-267; 1978-2 C.B. 171; amplifying: Rev. Rul. 75-59, 62-82, 61-57; 1961-1 C.B. 243 and 62-81 62-81; 1962-1 C.B. 153; amplified by: Rev. Rul. 78-267 79-174; 1979-1 C.B. 99; modifying: Rev. Rul. 57-599, 62-82; 1962-1 C.B. 155; amplified by: Rev.Rul. 78-267 distinguished by Rev. Rul. 87-59 66-6; 1966-1 C.B. 160; amplifying I.T 3985, 1949-2 C.B. 51 80-175; 1982 C.B. 67; revoking: Rev. Rul. 72-372 & I.T 3287, 1939-1 C.B. (Pt. 1) 138 81-2; 1981-1 C.B. 78 66-7; 1966-1 C.B. 188; amplifying: I.T 3985, 1949-2 C.B. 51 82-78; 1982-1 C.B. 30 66-9; 1966-1 C.B. 39; distinguished by Rev. Rul. 87-59 84-67; 1984-1 C.B. 28; modifying and superseding Rev. 66-18; 1966-1 C.B. 59; modified by: Rev. Rul. 71-228 Rul. 76-6 67-51; 1967-1 C.B. 68 84-81; 1984-1 C.B. 135 68-281 1968-1 C.B. 22; distinguished by Rev. Rul. 73-217 87-59; 1987-2 C.B. 59; amplified by Rev. Rul. 90-61, 71-254 1971-1 C.B. 78 distinguishing Rev. Rul. 79-174 and 66-9 71-228 1971-1 C.B. 53; modifying Rev. Rul. 66-18 88-99; 1988-2 C.B. 33; clarifying Rev. Rul. 68-281 71-334 1971-2 C.B. 248 90-61 ; 1990-2 C.B. 39. amplifying Rev. Rul. 87-59 71-354 1971-2 C.B. 246 94-27; 1994-1 C.B. 26 72-252 1972-1 C.B. 193

119 Appendix III. 1RS Form T (Timber)

121 Form T (Timber) Forest Activities Scheduies OMB No. 1545-0007 (Rev. Apnl 1995) ^ Attach to your tax return. Department of th« Trsasury Attachment Intamal Rtvtnu« Sarvica For tax yar tndtd , 19 Sequence No. 89 Name(s) as shown on return Identifying number

Paperwork Reduction Act Notice whether the acquisition is a purchase, exchange, gift, or We ask for the Information on this form to carry out the Internal inheritance. Revenue laws of the United States. You are required to give us Schedule C—Complete for any year you sell or exchange the Information. We need it to ensure that you are complying timber, timber cutting contracts, or forest land. with these laws and to allow us to figure and collect the right amount of tax. Schedule D.—Complete if you claim a loss on your income tax The time needed to complete and file this form will vary retum for timber lost due to fire, wind, theft, or other causes. depending on Individual circumstances. The estimated average Schedule B.—Complete only if you pay or incur expenses for time is: reforestation of forest land or for timber stand activities. Recordkeeping 37 hr, 4 min. Examples of reforestation expenses are oosts for site preparation and for planting or seeding. Examples of timber stand activities Learning about the law or the form 35 min. are precommercial thinning and fertilization. Preparing and sending the form to the 1RS . . 1 hr, 14 min. Schedule F.—Complete for each timber account that has If you have comments conceming the accuracy of these time changed in quantity or dollar amount. A timber account may estimates or suggestions for making this form simpler, we would be change in quantity or dollar amount as a result of acquisitions, happy to hear from you. You can write to the 1RS. See the dispositions, the cutting of timber, capitalized expenditures, Instructions for the tax retum with which this form is filed. casualty or theft losses, corrections, additions for growth, and transfers from other accounts. Use Schedule F to figure General Instructions depletion for timber cut or the basis for timber sold or lost during Section references are to the Internal Revenue Code unless the tax year. Also use Schedule F if you treat the cutting of otherwise noted. timber as a sale or exchange under section 631(a). Who must file.—If you claim a deduction for depletion of timber Schedule Q.—Complete to show changes in ownership of land or for depreciation of plant and other improvements related to during the tax year. timber accounts, or elect under section 631(a) to treat the cutting of timber as a sale or exchange, you must complete and Schedule H (optional).—Complete if you incur expenses for the attach Form T to your income tax retum. Generally, you should building of logging truck roads. If a timber company builds the file Form T when you sell or cut standing timber or are involved road but later charges the landowner for the cost, the landowner in other timber transactions. should complete Schedule H. Complete Form T in accordance with sections 611. 631, and Schedule I (optional).—Complete if you incur expenses for 1231 and related regulations. Complete only Schedules C and F building drainage structures, such as ditches. if you are a small-woodlot owner whose only timber-related For more infonmation about Federal income tax rules and activity during the year was an isolated sale of timber. recordkeeping for forestry activities, see Agriculture Handbook Overview of form.—^orm T has nine schedules. Use the No. 681, Forest Owners' Guide To Timber Investments, The following rules to determine which schedules to complete. Federal Income Tax. and Tax Recordkeeping. To order this Schedule A (optional).—If you do not send the Schedule A handbook, call 202-512-1800 (not a toll-free number) or write the maps in with Form T, you must make them available if your Superintendent of Documents, U.S. Government Printing Office, retum is examined. Washington, DC 20402. The handbook costs $7.00 (subject to Schedule B.—Complete for any year you acquire timber, change); its GPO stock number is 001-000-04540-7. timber cutting contracts, or forest land. Complete Schedule B Schedule A Maps (OptionaO 1 This schedule consists of a map (or maps) of your timber enough detail to show clearly the location of: (a) timber cutting properties. Whether you file the maps with your income tax retum contracts acquired separately from the land; (b) forest lands is your option, but you must make them available if your retum is acquired; (c) areas where you cut timber; (d) timber sold or examined. Maps of convenient size are desirable, varying in scale othenA/ise disposed of under cutting contracts; (e) forest land from approximately 4 inches to the mile in small tracts to V2 inch sold or othenA^ise disposed of; and (f) forest land sold or to the mile in tracts larger than 200,000 acres. The maps should otherwise disposed of with the timber cutting rights reserved to show your name and the tax year. Give standard map symbols in you or outstanding in third parties. Schedule B Acquisitions Report acquisitions during the tax year (such as by purchase, pay-as-cut basis, except for those under which all cutting is exchange (whether taxable or not), gift, or inheritance) of completed within the tax year, do not complete lines 6 timber, timber cutting contracts, or forest land. Report through 10. Instead, briefly give the provisions of the separately each acquisition of $10.000 or more. You may purchase or lease agreement, including the number of years combine acquisitions of less than $10,000 for each account, from the effective date to the expiration date, annual and omit lines 4 and 5. For an acquisition by gift or minimum cut or payment, and the payment rates for different inheritance, do not complete line 6 through 8b. For an kinds of timber and forest products. Follow the format of lines acquisition or lease of timber-cutting rights on a 3 through 10 on additional sheets if necessary.

_3_ Name of block and title of account ^ 4 Location of property (by legal subdivisions or map surveys)

' You must include your timtw in one or more accounts. Generally, each account must include alt your timber that is located in one -block." A block may be (a) an operational unit that includes all timber that wouW logwally go to a single point of manufacture, (b) a togging unit that includes all timber that would logically be removed by a single logging devetopment. or (c) an area established by the geographk:al or polittoal boundaries of logical management areas. Timber acquired under a cutting contract may not be included in part of a btock. but shouW be kept in separate accounts. For exceptk>nal cases, the timber in a given block may be divided into two or more accounts. See Regulattons sectton 1.611'3(d) for more infomiatton. Cat. No. 16717G Form T (Timber) (Rev. 4-95)

122 Form T (Timber^ (Rev. 4-95) Page 2 Schedule B Acquisitions (Continued) 5a Name and address of seller or person from whom property was acquired b Date acquired

Amount paid: a In cash b In interest-bearing notes . c In non-interest-bearing notes 7a Amount of other consideration b Explain the nature of other consideration and how you determined the amount shown on line 7a:

8a Legal expenses b Coiising. surveying, and other acquisition expenses

9 Total cost or other basis of property (add lines 6a through 8b) 10 Allocation of total cost or other basis on books: Coet or other Unit Number of units Total cost or other basis beeie per unit a Forested land Acre b Other unimproved land Acre c Improved land (describe) > Acre

Merchantable timber (Estimate the quantity of merchantable timber present on the acquisition date. (See Regulations section 1.611-3(e).) Details of the timber estimate, made for purposes of the acquisition, should be available if your retum is examined.)

Premerchantable timber. (Make an allocation here only if it is a factor in the total cost or value of the land.)

f Improvements (list separately)

g Mineral rights h Total cost or other basis (same as line 9) Schedule C Profit or Loss From Land and Timber Sales 11 Generally, report alt dispositions during the tax year (such as lines 15, 19, and 20 only for amounts that must be reported by sale or exchange, whether taxable or tax-free) of timber, on your current year income tax retum. Instead of filling in timber cutting contracts, or forest land. Do not report lines 16, 17. and 18, briefly state the provisions of the sale or dispositions by gift or distributions made by an estate to a lease agreement, including the number of years from the effective date to the expiration date, annual minimum cut or beneficiarv Report each sale involving total consideration of $10.000 or payment, and the payment rates for the different kinds of more You may combine sales of less than $10,000 for each timber and forest products. You may combine small sales or timber or land account and omit lines 13 and 14 for each leases of timk)er-cutting rights on a pay-as-cut basis that combined small sale. For a sale or lease of timber-cutting were completed within the tax year. Follow the fonmat of lines rights on a pay-as-cut basis, to be paid for at intentais during 12 through 20 on additional sheets if necessary. the cutting period according to the number of units cut, fill in

12 Name of block and title of account

13 Location of property (by legal subdivisions or map sun/eys)

123 Form T (Timber) (Rev. 4-95) Page 3 Schedule C Profit or Loss From Land and Timber Sales (Continued) 14a Purchaser's name and address b Date of sale

15 Amount received: a In cash b In interest-bearing notes . . 0 In non-interest-bearing notes

16 Amount received in other consideration 17 Explain the nature of other consideration and how you determined the amount shown on line 16 ► 18 Total amount received for property (add lines 15 and 16) 19 Cost or other basis of property: Cost or other Total cost or other basis Unit Number of units basis per unit a Forested land Acre b Nonforested land Acre c Improved land (describe) ► Acre

Merchantable timber. (Estimate in detail the quantity of merchantable timber on the date of sale or exchange. Include the quantity of timber] in each species of timber by diameter at breast < height (D6H) classes. State the log mle used if the unit of measure is thousand board feet (MBF), log scale.)

e Premerchantable timber

f Improvements (list separately)

9 Mineral rights. h Total cost or other basis i Direct sale expenses (cruising, marking, selling).

20 Profit or loss (line 18 less the total of lines 19h and 19i) Schedule D Losses 21 If you had losses during the tax year from fire, wind, theft, or other causes, and you claimed the loss on your income tax return, show separately the proof of loss for each timber account and complete lines 22 through 25. 22 Cause of loss

23 Location and area of land on which loss took place

24a Total loss before any insurance recovery b Less amount received from insurance . c Loss as claimed on tax return 25 Explain in detail how you determined the total loss on line 24a:

124 Porm T (Timber) (Rev. 4-95) Page 4 Schedule E Reforestation and Timber Stand Activities 26 Summarjze your expenses for reforestation and timber stand Planting or seeding.—Report the expenses you incurred activities on this schedule. Keep detailed information to during the tax year for planting seedlings or sowing seed to support the costs reported in this schedule and make it reforest the land. Report separately for each depletion available if your retum is examined. Report on Schedule E account, block, tract, or operating area tributary to a mill or expenses such as supplies, labor, overhead, transportation, mill complex. Report contract work separately from your tools, and depreciation on equipment. employees' work. Site preparation.—Report all expenses incured during the Precommercial thinning or fertilization.—Report all tax year for preparing the land for planting or seeding expenditures that must be capitalized and items that you (including natural seeding). Include expenses for clearing the elect to capitalize. Also, list on a separate attachment items land of brush and cull trees by burning, disking, chopping, that are currently deductible. Report separately for each shearing and piling, spraying with herbicides, or other depletion account, block, tract, or operating area tributary to measures taken to aid successful site reforestation. Report a mill or mill complex. Report contract work separately from separately for each depletion account, block, tract, or your employees' work. operating area tributary to a mill or mill complex. Report contract work separately from your employees' work.

Kind of activity (burning, chopping, Account block, tract or area spraying, planting, seeding, thinning, Number of Total pruning, fertilizing, etc.) acres treated expenditures

Total Schedule F Capital Returnable Through Depletion On lines 27 through 42, give the data for each timber account purchases with the opening balances and use the average separately. Cover any changes that have taken place during the depletion rate shown on line 34 for all timber cut or sold, tax year. Attach as many additional pages of this schedule as regardless of how long held. If you express timber quantity in needed. If you deplete on the block basis, combine new MBF, log scale, name the log mle used ►

27 Name of block and title of account ^

28 Estimated quantity of timber and amount of capital retumable through depletion at end of the immediately preceding tax year 29 Increase or decrease of quantity of timber required by way of correction^.... 30a Addition for growth (period covered ► years) b Transfers from premerchantable timber account c Transfers from defended reforestation account 31 Timber acquired during year 32 Addition to capital during year* 33 Total at end of year, before depletion (add lines 28 through 32, in each column) 34 Unit rate retumable through depletion, or basis of sales or losses (line 33, column (b), divided by line 33, column (a)) 35 Quantity of timber cut during year 36 Depletion sustained (line 34 multiplied by line 35) 37 Quantity of standing timber sold or otherwise disposed of during year 38 Allowable as basis of sale (line 34 multiplied by line 37) 39 Quantity of standing timber lost by fire or other cause during year 40 Allowable basis of loss (line 34 multiplied by line 39) 41 Total reductions during year a Add line 35. column (a); line 37, column (a); and line 39, column (a) b Add line 36, column (b); line 38, column (b); and line 40, column (b\ 42 Net quantity and value at end of year (line 33, column (a) less line 41a, column (a); andline33, column (b) less line 41b. column (b)).

'If MBF. log scale, is not the unit used, state what unit you used and explain it. 2*^. J^ ^..««fiL in MBF loa scale, or other unit remaining at the end of the year for changes in reinventofy. standards of use, scattered and/or indefinitely ascertained Adiust the 2¡J^¿y^of the fon^ estimate, or change in the log scale if the log rule now in use differs from the one used as basis for depletion in earlier years. If you make a chSioe. clearly state the basis for it. r *», ^MAinn to show the individual items included. Include expenditures for taxes, administration, protection, interest actually paid. etc.. if you did not treat these Analyze the ^^^^rJ^g^jj^tions on your retum. Carry expenditures for reforestation, such as site preparation, planting, seeding, etc.. in a separate deferred account, expenditures as expcna« ucw*v> / ^

^ n..antitv of cut timber that was sold as logs or other rough products 125 Form T (Timber) (Rev 4-95) Page 5 Schedule F Capital Returnable Through Depletion (Continued) 44 Are you electing, or have you made an election in a prior tax 47 Describe in detail the characteristics of the timber that affect year that is in effect, to report gain or loss from the cutting of its value, such as total quantity, species, quality, quantity per timber in accordance with section 631(a)? (This election is acre, size of the average tree, logging conditions, distance to binding for all eligible timber cut in the election year and all markets, and the like. subsequent years. You may revoke the election only with 1RS 48 Give evidence in the form of actual sales of comparable timber as consent, unless you made the election for a tax year of the valuation date, along with other value evidence used. beginning before 1987.) □ Yes □ No Include a computation showing the difference between the cost If "Yes," furnish the infomnation asked for in items 45 through (excluding timber or stumpage cost) and value of the primary 51. wood product (logs or other roundwood, chips, etc.) at the mill or plant. Give detailed evidence that permits a comparison with the 45 Gain or loss on standing timber as reported on Form 4797. timt>er on which you report a value. Sales of Business Property. Show the adjusted basis for depletion and the fair market value, by species and unit rates 49 For all purchases and sales of timber you make, and for all if reported on a species basis. Section 631(a) requires you to other transactions you report, fumish the relevant information determine the fair market value of timk>er cut during the year from lines 2 through 20. for timber you owned, or held under contract right to cut, for 50 Fumish the following additional information: more than 1 year. The fair market value is the value of the a. Location of the sawmill, log market, or other point of tiríiber as it stood in the forest on the first day of the tax year. delivery of the logs or wood to the user or buyer. 46 Fumish the date of acquisition of timber that was cut in the tax b. The total MBF. log scale, cords, or other units of timber year, if acquired after March 1. 1913; the quantity of timber cut. and the length and diameter of the average log or the remaining (adjusted for growth, connection of estimates, changes average number of units per tree. in use, and any change in the log rule used); and the adjusted c. The percentage of rough lumber grades, by species, basis at the beginning of the tax year. State the acreage cut over manufactured from the timber during the yean or, if cut and the amount of timber cut from it during the tax year and the timber is sold as logs, the percentage of log grades, by log rule or other method you used to determine the quantity of species. timber cut. If you kept depletion accounts by separate tracts or purchases, give the infomnation separately for each tract or 51 Section 631(a) applies only to timber owned, or held under a timber purchase. contract right to cut, for a period of more than 1 year. In your records show the quantity of timber cut that you held for ' If you used an average depletion rate based on the average more than 1 year. Show separately the quantity of timber cut value or cost of a timber block in eariier years, the adjusted that was held for less than 1 year. Also, the scale of logs basis refen^ed to In section 631(a) is the average basis shown purchased during the year must be shown by species and on lines 34, after adjustment. quantity and excluded from the quantity shown as cut under section 631(a). Records must also show the number, cost, and point of delivery of purchased logs by species and grade.

Schedule G Land Ownership 52 Show changes in land accounts as earned on your books. Attach as many additional sheets as you need, following the format of lines 53 through 58. Total cost 53 Name of block and title of account ► or other basis. Give Acres amount of March 1, Average rate 1913, appreciation, if per acre includecl 54 Balance at beginning of year 55 Acquisitions during year 56 Sales durina vear 57 Other changes 58 Balance at end of year (add lines 54 and 55, less lines 56 and 57) . Optional Schedules

59 If the supporting statements for Schedules H and I are too numerous to file with your return, keep this infomnation and make it available if your retum is examined. Include separate cost accounts for construction by you and by the contractor. Schedule H Road Construction Cost 60 Report on lines 61 and 62 the expenditures incun^ed for road construction during the tax year. Use a separate schedule for each depletion account, block, tract, or geographic area tributary to a mill or mili complex. 61 Roads constructed on lands owned in fee: a Miles constructed ► b Amount capitalized to nondepreciable account 0 Amount placed in depreciation account. . . d Amount claimed as an ordinary expense . . e Total amount spent (add lines 61b through 61 d) 62 Roads constmcted for logging timber held under leases or cutting contracts having a term of 2 years or longer. a Miles constmcted ► b Amount to be amortized c Amount claimed as an ordinary expense d Total amount spent (add lines 62b and 62c) : 126 Po^m T (Timber) fRev. 4-95) Page 6 Schedule I Drainage Structures 63 Report expenses incurred during the tax year for construction of water level control devices such as ditches and canals. List each kind of structure separately for each depletion account, block, tract, or geographic area tributary to a mill or mill complex: a Kind of structure ► b Miles constructed ► t Purpose of structure ►

d Amount capitalized to nondepreciable account e Amount placed in depreciable or amortizable account f Amount reported as an ordinary expense g Total amount spent (add lines 63d through 63f)

127 Appendix IV. Forms for Recording Timber Transactions

The following accounting forms are provided so that you can others, you may have to experiment until you get the right record your timber transactions. If your operation is small, mix. The example in Table XIV-1 indicates the amount of you can use only the journal forms to record transactions space to allow for each account and the type of activities to when they occur as suggested in Figure XIV-1 of Chap- record. ter XIV. As the scope of the timber investment increases, however, you can establish ledger accounts for land, mer- Because of the passive loss rules (see Chapter V), it may chantable timber, premerchantable timber, equipment, and also be important for noncorporate timberland owners to other items as seems appropriate for your goals and the size record the time that they spend on their timber activities. of the property (see Chapter XIV, Figures XIV-2. XIV-3, XIV-4. Journal entries can include the date, description, mileage, and XIV-5). The entries recorded in the business journal can and hours spent on various woodland activities, which will then be transferred (posted) to the respective ledger ac- help to ensure that these items are not forgotten. Such counts as shown in Chapter XIV. The blank pages can be entries, if kept on a timely and routine basis, will help to copied as required and the names of the ledger accounts document the hourly requirements for material participation written in as needed for timber transaction purposes. Due to purposes, as well as the purpose for which certain activities the relatively small number of transactions for some ac- are accomplished. counts, and possibility of a larger number of transactions for

129 Business Journal ' Date Description of activity—account quantities, Reference Debits Credits and hours spent (for passive ioss mies) ($) ($) J

130 Land Journal

Date Legal Description: Deed# Reference Debits Credits permanent, nondepreciable Improvement.etc. ($) ($)

Record depreciable items associated with the land in the account for depreciation.

131 Merchantable Timber Journal ($ basis, volume). • Date Description (basis): Purchases, transfers, Reference Debits Credits 11 capitalization, and disposals ($) ($) 1

*

Merchantable timber (volume): Cords, MBF, Additions, Removable, 11 tons, etc. units units

132 Young Natural Growth Account ($ basis, acres).

Date Description: Purchases, establishments, Reference Debits Credits and disposals ($) ($)

n^

Young growth account (volume): Acres Additions, Removable, units units

133 Reforestation Account ($ basis, acres).

Date Description: Purchases, establishment cost Reference Debits Credits 1 and disposals ($) ($) 1

Plantation account (volume): Acres Additions, Removable, units units

134 Equipment Account.

1 Date Description: Type, make, model, and year Reference Debits Credits ($) ($)

135 index

Page Page Accounting methods 75 Farming 24.40 Accounts—also listed by name 18. 76, 77.135 Fire, losses due to 43 Active income (loss) 27. 28 Fire protection expenses 27 Administrative law 67.68 Forest products 42, 55 Ad valorem taxes, see property taxes 15.27 Forestation expenses 19 Agricultural conservation program (ACP) payments 40 Amortization of 19, 24 Allocation of costs 17 Forester 11.13, 27 Allocation of basis 17 Forestry Incentives Program (FIP) payments 40 Allowable basis 36.44 Form T 20-23. 32. 33, 37.122 Alternative minimum tax 54. 55 Form 4797 38, 39. 42. 47. 48 Amortization 19,24 Gain or loss, how computed 31,34 Audits and appeals 69 Gifts, basis of 17 Basis 17,48 Growth, accounting for 31 Brush control 19. 92 Hobby vs. business 15 Business expenses, how to recover 15, 27 Hobby expenses, how to recover 15 Business vs. hobby 15 Holding period 35, 36, 38 By-products 42 Hurricanes, losses due to 43 Capital account 17, 18, 76, 77 Ice storm, losses due to 43 Capital asset 17. 35, 36 Improvements to land 18 Capital gains and losses 34,35 Independent contractor 56,57 Capital vs. expense—see specific items 17,27 Information returns 42 Capitalization 17. 28, 76 Inherited property, basis of 17 Carrying charges 27, 29 Insects, losses due to 43, 94 Case law 68 Installment sales 53,54 Casualty losses 43 Interest 6,30 Christmas trees, expenses of producing 59, 91 Investment, property held for 15, 29, 35 Christmas trees, income from 59, 60 Investment expenses, how to recover 27, 29 Christmas trees, as timber 59, 60 Investment tax credit 19, 25 Community property 63 Involuntary conversions 43, 93 Condemnations 45, 46, 47 Insurance, proceeds from 44 Conservation easements 51, 52 Insurance expenses 27 Conservation Reserve Program 24.40 Journal 75, 76, 81 Consulting forester 11. 27, 48 Land account 18, 76 Contract right to cut vs. service contract 36, 39 Leases 4,15,38 Co-ownership 63 Ledger 76 Corporations 16, 64 Life estate 63 Cost—^see specific items 17 Limited liability companies 64 Courts 68,69 Limited partnership 64 Cruising expense 31 Logging roads 25, 26. 91 Cutover land 42 Losses 43-48, 93, 94 Cutting as a sale or exchange 38 Lump-sum sale 35,36 Cutting contracts 36.38 Management expenses—see specific expense 27 Cutting rights 36.38 Marking of timber 31 Date of cutting 38 Material participation 28, 76 Depletion allowance 31. 34. 36. 44. 91 Merchantable timber 18, 43, 76, 82 Depreciation expenses 25, 26. 27 Minimum tax 54,55 Disposal with a retained economic interest 36.71 Noncasualty losses 48 Drought, damage due to 3,43 Noncommercial thinning 27 Economic interest, defined 36 Operating expenses—see specific item 27 Economic decision criteria 5, 6 Ordinary income 5, 34, 36, 38, 42 Elections by taxpayer 24, 27, 38 Outright sales of timber 35 Employee 56,57 Owner 36,38,39 Equipment 19,25.45.76 Partial destructions, losses due to 44, 45 Estates 16 Partnerships 15, 60, 63, 64 Evergreen trees, defined 38.59 Passive activity 28,29 Exchanges 17.46 Passive income (loss) 28, 29 Fair market value 17.19. 38. 60. 92 Personal use, property held for 15,43

137 Page Plantation account 18, 76 Planting expenses 18 Portfolio income (loss) 29 Preproductive period 12, 59 "Primarily for sale," timber held for 36 Profit, defined for timber investments 15, 27 Pruning expenses 59, 91 Quantity of timber, determination of 18, 31, 36 Recordkeeping requirements 28, 75 Reforestation expenses 19, 24, 76 Reforestation expenses, amortization of 19, 24, 76 Reforestation tax credit 25 Rental income 4,15, 40 Rental expenses 26 Retained economic interest 36 Revocation of election under Section 631(a) 40 Roads 18,25,26 91 Sale ownership 63 Sales, types of 35, 36, 38 Salvage of damaged timber 44 Scaling of logs 38 Schedule D 36, 38 S corporations 64 Self-employment tax 34, 55 Selling expenses 31 Shearing expenses 59, 91 Site preparation expenses 6,19, 24 Social security tax—see self-employment tax 55, 56 Soil and water conservation expenses 24, 40 Stewardship 51 Stewardship Incentive Program 40 Stumpage 39 Stumps 42 Taxes, deductible and nondeductible 30 Theft, losses from 45 Thinning expenses 27 Timber accounts 18, 31, 76 Timber cruise expenses 31 Timber, defined 38 Timber stand improvement (TSI) expenses 24, 28, 42 Timeline 6 Tops, limbs, chips 42 Tornado, losses due to 43 Trade or business, held for use in 15, 25, 28 Travel expense 27 Trees, damage to 43, 44, 45 Trusts "Iß Valuation 18. 38 Windstorm 43 Year of cutting 38 Year of deduction for casualty loss and theft 44, 45, 46 Young growth account 18, 84 Young growth, losses of 44,45

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