Forest Owners' Guide to Timber Investments, the Federal Income Tax, and Tax Recordkeeping

n / / .ai!¿'í, United States ¡I Ji J Department of -^^y' Agriculture Forest Owners' Guide Forest Service; To Timber Investments, Agriculture Handbook No. 681 The Federal Income Tax, and Tax Recordkeeping United States Department of Forest Owners' Guide Agriculture Forest to Timber Investments, Service Agriculture the Federal Income Tax, Handbook No. 681 and Tax Recordkeeping William L Hoover, Professor of Forestry, Purdue University, West Lafayette, IN William C. Siegel, Project Leader for Economic and Legal Research, Southern Forest Experiment Station, USDA Forest Service, New Orleans, LA George A. Myles, Taxation and Finance Specialist, Cooperative Forestry, State and Private Forestry, USDA Forest Service, Washington, DC Harry L Haney, Jr., Associate Professor Forest Management and Economics, Forest Management and Economics, Virginia Polytechnic Institute and State University, Blacksburg, VA. Harold E. Burghart, Timber Tax Law Specialist, Internal Revenue Service, reviewed the manuscript and made many valuable suggestions for improvement July 1989 Supersedes "A Guide to Federal Income Tax for Timber Owners," Agriculture Handbook No. 596, issued September 1982. Abstract Hoover, William L; Siegel, William C; Myles, George A.; and Haney, Harry L Jr. 1989, Forest Owners' Guide to ' Timber Investments, the Federal Income Tax, and Tax Recordkeeping. Agriculture Handbook 681. Washington, DC: U.S. Department of Agriculture. 104 p. Updates Agriculture Handbook No. 596, "A Guide to Federal Income Tax for Timber Owners," and incorporates changes made by the 1986 Tax Reform Act and the 1987 Revenue Act. Provides a framework for analysis of timber investments and a chapter on timber tax planning. Discusses Federal income tax considerations for timber including: capital costs, reforestation tax incentives, depreciation, operating expenses and the passive loss rules, timber capital gains, installment sales, casualty losses, alternative minimum tax, self employment taxes, and Christmas tree production. Chapters explain how to research tax questions, sources of tax assistance, and how to keep forest records. Blank tax and record forms, a glossary, and index are also provided. Contents Page Page Introduction 1 Business 9 Purpose 1 Active business interest 9 Sources of assistance 1 Passive business interest 9 Internal Revenue Service review 1 Types of taxpayers 9 Structuring your timber activities 9 Timber Investment Considerations 2 Characteristics of a timber investment 2 V. Cost Considerations 1 Risk 2 Capital costs 1 Investment expenditures 2 Original and adjusted basis 1 Land 2 Purchased assets 1 Merchantable timber 3 Inherited assets 1 Annual management costs, property Assets received by gift 1 taxes, and interest 3 Other types of acquisition 1 Investment revenues 3 Allocation of original basis 1 Timber sale 4 Accounts established 12 Hunting leases 4 Land account , 12 Miscellaneous revenues 4 Depreciable land improvements 12 Economic considerations 4 Timber accounts 12 General economic trends 4 Equipment accounts 12 Economic decision criteria 4 Reforestation tax incentives 13 Net present value 5 Amortization 17 The benefit/cost ratio 5 Credit 17 Internal rate of return 5 Depreciation and the Section 179 Equal annual equivalent 5 deduction 17 Time line 5 Section 179 deduction 17 A forest investment example 5 Depreciation 18 Summary 7 Operating expenses and carrying charges 19 Tax Planning 8 The passive loss rules 20 The planning team 8 Timber held as part of a trade or Developing an integrated plan 8 business in which the taxpayer Introduction 8 materially participates 20 Advantages of timber investments 8 Material participation 20 Estate planning role 8 Reporting expenses 21 Planning implications 8 Timber held as part of a trade or Substantial initial investment 8 business in which yo do not materially Long preproductive period 8 participate 21 Multigenerational investment Timber held as an investment 22 horizon 8 Management costs 22 Tax considerations when timberland is Taxes 22 purchased 8 Interest 22 Tax considerations when selling timber .. 8 Reporting expenses 22 IV. General Tax Considerations 9 VI. Income Considerations 23 Types of forest ownership and Timber sale receipts 23 operation 9 Determining the amount of gain or Purpose for holding timber 9 loss 23 Personal use 9 Adjusted basis 23 Investment 9 How to recover your basis 23 III Page Page Recovery of basis—disposal of Destruction of unmerchantable standing timber 23 timber 35 Recovery of basis—cutting of Buildings and equipment 35 standing timber 23 Determining the decrease in fair Determining the kind of gain or loss ... 24 market value 35 Capital gain status is still Theft losses 35 important 26 Year deducted 35 Capital gains from timber Reduce theft losses by anticipated transactions 26 recovery 36 Sale of standing timber for a lump Multiple damages 36 sum 27 Condemnations 36 Disposal of standing timber with an Condemnations for right-of-way economic interest retained easements 36 (Section 631(b)) 28 Basis for figuring gain or loss 36 The cutting of standing timber with an Recovery of expenses 36 election to treat as a sale Casualties and thefts 36 (Section 631(a)) 28 Condemnations 36 Government program payments 30 Postponing gains from involuntary Other timber-related receipts 31 exchanges 36 Determining the gain 37 VII. Other Tax Considerations 32 Requirements to postpone gain 37 Installment sales 32 Basis of replacement property 37 Introduction 32 Reporting gains and losses from Calculating installment sale income ... 32 casualties, thefts, and Gross profit percentage 32 condemnations 37 Adjusted allowable basis 32 Casualties and thefts 37 Selling price 32 Reporting gain or loss—property Payments 32 held for 1 year or less 37 Escrow accounts 32 Reporting gain or loss—property Electing out 33 held for more than 1 year 37 Unstated interest and imputed Reporting gain or loss from interest 33 income producting property 37 Reporting installment sales 33 Condemnations 37 Sales to related parties 33 Property held for 1 year or less... 38 Casulaties, thefts, and condemnations 33 Property held for more than Discussion limited to timber 33 1 year 33 Normal losses not deductible 33 Property held primarily for sale... 38 Noncasualty losses 34 Property held for personal use ... 38 Casualty losses 34 Alternative minimum tax 39 Disease or insect infestation 34 Self-employment, social security tax 39 Loss of potential income is not Treatment of spouses 40 deductible 34 Excluded income items 40 Combinations of factors 34 Christmas tree growers 40 Determining the amount of deductible Forest products 40 loss 34 Agricultural Conservation Program Determining volume of timber payments 40 destroyed 34 How to calculate self-employment Determining basis of timber tax 40 destroyed 34 Year of deduction 34 IV Page Page Including timber gains in self- A tree farm journal 50 employment income to guarantee A tree farm journal with accounts 50 benefits 40 Capital accounts 53 Christmas tree production 41 Expense accounts 54 Capital income accounts 54 VIII. Researching A Tax Question 43 Ordinary income accounts 54 Statutory law 43 General business accounts 54 Administrative law 43 Revenue rulings 43 Glossary 59 General Counsel Memoranda 43 Revenue procedures 44 Appendix I—Summaries of Selected Revenue News releases, notices, and Rulings 63 announcements 44 Private letter rulings 44 Appendix II—Form T (Timber) 67 Technical advice memoranda 44 Case law 44 Appendix III—Forms for Recording Your Timber Federal court system 44 Transactions 73 Tax Court 44 Business journal 75 District Courts and Claims Court 44 Land account 87 Circuit Courts of Appeals 45 Merchantable timber account ($ basis, U.S. Supreme Court 45 volume) 89 Interpreting case law 45 Young growth account ($ basis, volume) 91 Audits and appeals 45 Equipment account 93 How returns are selected for examination 45 Index 95 The examination process 45 If you agree 46 If you do not agree 46 How to stop interest from accruing 46 Appeals within the 1RS 46 Appeals to the courts 46 Claims for refund 46 Additional information 47 Example of tax research 47 IX. Sources of Tax Assistance 48 1RS publications 48 Association publications 48 Commercial tax services 49 Other sources 49 Current developments 49 Guidebooks 49 X. Forest Records 50 Tax purposes 50 Management information 50 Accounting methods 50 Record keeping methods 50 Shoe box 50 Chapter I. Introduction Purpose A new chapter, on researching a tax question, has been added to assist you or your tax advisor in understanding The purpose of this handbook is to encourage good forest the relationship between statutory and administrative law. management by presenting methods of analyzing forestry Audits and appeals procedures and how you take your case investments, and by explaining the Federal income tax as it to court if you disagree with the Internal Revenue Service pertains to timber. It also provides a system and blank (1RS) are explained. A comprehensive example explains tax forms to enable you to keep the necessary records for tax research procedures. Appendix I summarizes pertinent rev- purposes and to more effectively manage your investment. enue rulings dealing with timber. Appendix II provides rele- This publication is a major revision of Agriculture Handbook vant tax forms. Appendix III provides forms for recording 596, "A Guide to Federal Income Taxes for Timber your timber transactions. Owners". The previous volume has been updated for changes made by the 1986 Tax Reform Act and the 1987 Sources of Assistance Revenue Act. Chapter IX lists sources of tax assistance. Local offices of Since there is no longer a differential in effective rates the Internal Revenue Service can supply taxpayer publica- between long-term capital gains and ordinary income, the tions to answer most questions you will have about income section on timber capital gains has been modified. Passive taxes. Foresters can provide assistance in determining tim- loss is a new concept brought about by the 1986 Act; a ber values, establishing volumes, and developing manage- new section on passive loss rules as they pertain to timber ment plans. You may wish to consult an accountant or is added.

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