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Tax Considerations for Forest Landowners. Mike Jacobson School of Forest Resources Penn State Nov 11, 2008 PSU Webinar. Facts. Taxes are a major cost of doing business Proper tax planning is every bit as important as the silvicultural techniques used to grow profitable forest crops.

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Tax Considerationsfor Forest Landowners

Mike Jacobson

School of Forest Resources

Penn State

Nov 11, 2008

PSU Webinar

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  • Taxes are a major cost of doing business

  • Proper tax planning is every bit as important as the silvicultural techniques used to grow profitable forest crops.

  • Congress has provided several favorable advantages and elections to STIMULATE INCREASED PRODUCTIVITY from the nation’s private forest lands.

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  • Its complicated stuff

  • “the hardest thing in the world to understand is income tax”

    Albert Einstein

  • This information and discussion should be treated as EDUCATIONAL, not legal advice.

  • Every situation is different

  • Discuss with professional tax team

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Types of Forest Taxes

  • Types of forest taxes

    • Income taxes

      • 2005 changes

        • Timber sales and capital gains (631b)

        • Reforestation deductions

    • Estate taxes

      • $2 m credit 2006-2008

    • Property taxes

      • Clean & Green (in PA)

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  • Establishing basis

  • Expenses

  • Timber Income

  • Other tax considerations

  • Estate planning

  • Conservation easements

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Establishing a “basis”

  • A capital investment in income-producing property

  • The law usually requires that basis be capitalized – held in a capital account – until the property is sold

  • Tax rule: any expenditure of asset with life of greater than 1 year must be capitalized

  • Basis is the book value of asset

    • determined by how much you paid for it

  • Recover basis with timber sale

  • Use Form T

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Original Basis

  • Purchase—Total cost to acquire the property, NOT just its purchase price and NOT its fair market value

  • Inheritance – Property’s fair market value on the date the decedent died OR the alternate valuation date (earlier of 6 months after death or date any estate asset is sold)

    Usually results in a “step-up” in basis

  • Gift—Lower of donor’s basis (carry-over basis) or property’s fair market value

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Original Basis

  • Ideally, determine original basis immediately after you acquire timber or forestland

    • If you postpone process for several years, you may need the help of a forester to determine the trees’ original volume and value

  • Allocate original basis proportionately among your capital accounts – for example, Land Account, Timber Account

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Adjusted Basis

  • Adjust capital accounts

    • Up by the amount of new purchases or investments

    • Down as you recover your investment

  • Adjusted basis – The balance left in a capital account after one or more changes have been made to the original basis

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Expenses- Advantage of being in the ‘business’?

  • Profit motive

    • The term “profit” also includes appreciation in the value of the assets.

  • Expensing

    • Expenses, property taxes, interest, etc are fully deductible against income from any source.

  • Expanded Section 179 deduction

    • New law effectively increases the limit to $250,000 and the phase out threshold to $800,000 for 2008

    • Reverts to $125,000 and $500,000 phase out in 2009

    • Bonus depreciation – 50% of adjusted basis

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Passive Loss Rules:The Three Categories

  • Timber held for the production of income, such as an investment, but which is not part of a trade or business.

  • Timber held as a part of a trade or business in which you do not “materially participate” (i.e., one in which your activity is “passive”).

  • Timber held as part of a trade or business in which you “materially participate” (i.e., one in which your activity is “active”).

    Tests for material participation

  • See questionnaire

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Operating expenses and carrying charges

  • Engaging in timber-growing for profit, these expenses can be deducted in the year they occur.

    • Examples Include:

      • Labor costs, consultant fees, timber stand improvement, precommercial thinning

    • Carrying costs - property taxes, interest

    • Can be capitalized in years your tract produces no income, but it usually is more beneficial to deduct them

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Timber Income

Both the amount and type of income received are important

  • Amount: Price – Expenses – Timber Basis

  • Type: Ordinary income or capital gain

    • Your primary purpose for owning timber (passive loss rules apply)

    • How long you have held it (how acquired)

    • How you dispose of it (3 methods)

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Type of Income is Important

  • Long-term capital gains - 15% and 5% for the bottom 2 brackets (0% for 2008-2010)

    • Highest ordinary income rates – 35%

  • Ordinary income you earn from timber is subject to self-employment taxes, at rates up to 15.3%

  • If you have large capital losses, apply them against any amount of capital gains

  • If you are retired, capital gains do not count toward the amount of income you can earn before your Social Security benefits are cut

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Qualifying for capital gains

How disposed of:

  • By a lump-sum sale or exchange

    • 1099 will be required

  • A Section 631(b) disposal, through a pay-as-cut contract or outright sale

  • A Section 631(a) transaction, by cutting the timber yourself, converting it to products for sale,

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Reforestation Amortizationand Deductions

  • The American Jobs Creation Act of 2004 changed the nature of the incentives

  • Two tax incentives reduce or eliminate the need to hold reforestation expenses in a capital account until you sell timber or timber products:

    • You can deduct reforestation expenses – up to $10,000 per year of qualifying reforestation

    • And for those expenses over $10,000 you can amortize – write off over an 8 year period

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Cost-share Payments

  • Generally, you are required to report government cost-share payments as part of your gross income (1099G).

  • However, under Section 126 of the IRS Code, all, or part of, certain government cost-share programs MAY be excluded from gross income.

    • ‘Substantial’ increase in annual income

  • Nevertheless, even if you choose to exclude an approved government cost-share payment, YOU MUST REPORT IT!

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Involuntary Conversion

  • If you lose timber in an involuntary conversion, you may be entitled to an income tax deduction, if not reimbursed by income or otherwise

    • Casualty loss,

    • Noncasualty loss

    • Theft loss

    • Condemnation

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Court cases – last 10 years

  • Have management plan

  • Keep good records

  • Get expert forestry advice

  • Show how improvements/expenses contribute to profit motive

  • Be careful about deducting travel/meal expenses

  • Absentee owners need to separate work been done for income or pleasure

  • Differentiate between personal and income activities, especially if live on the property

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Record Keeping

  • Form T

  • Records consist of many things:

    • Timber management plan

    • Receipts for business transactions

    • Odometer readings, diaries, time recording for the time spent managing the trade or business

    • Agendas to training meetings

    • Membership records in business related associations

    • Contracts

    • Invoices

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Estate planning- forestland issues

  • Explosive land values

  • High estate tax rates (unexpected values)

  • Families don’t realize need (unexpected heirs)

  • Reasonable planning horizon exceeds lifetime

  • “land rich, cash poor”

  • Uncertainty – law will change

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Three common phrases

  • “we don’t need a will’

  • ‘we have a will – we’re all set”

  • “we want to treat our children fairly, so we will divide everything equally among them”

    Communication is the key:

  • Dying is as much as part of living. To die well is to do so in consideration of the people you leave behind.”

  • Its not just about the taxes

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Federal Estate Tax Applicable Exclusion 26 U.S.C. 2010

  • Deaths in 2006-2008: Applicable Exclusion Amount = $2,000,000

    Year of Death Applicable Exclusion

    2009 $3,500,000

    2010 tax repealed

    (but carry over basis)

    2011 $1,000,000

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PA Inheritance Tax Rates

  • 0%:Spouses; Charities, gifts to government

  • 4.5%: Lineal Descendants;

  • 12%: Siblings

  • 15%: All others

  • Transfers Not Subject to Tax

    • Transfers to Spouses;

    • Life insurance proceeds regardless of where they are paid;

    • Family exemption of $3,500 to designated beneficiaries who satisfy the conditions

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Tools and strategies

  • Utilize unified credit

  • Marital deduction

  • Trusts

  • Life insurance

  • Installment payments

  • Special use valuation

  • Business transfers

  • Lifetime gifts ($24,000/year)

    • Gift tax does not end in 2010

    • Carry-over basis

  • Conservation easements

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Tax Planning Opportunities with Conservation Easements

  • Real estate taxes on easement property should be reduced.

  • Income tax benefits (IRC 170(h)) to individual landowners who donate or “bargain sale”

    • A Qualified Real Property Interest

    • to a Qualified Organization

    • Exclusively for conservation purposes

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Tax benefits from donation of easement

  • Charitable deduction in 50% of AGI (was 30%)

  • Excess deduction amounts can be carried forward for 15 additional tax years (was 5 years).

  • Additional exclusion of up to $500,00 (IRC 2031c.

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  • Part of forest management

    • Timber is long term

  • Be in the timber growing business

    • Capital gains

    • Expensing

    • Reforestation incentives

  • Establish “profit motive”

  • Recordkeeping

  • Plan your estate now!

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Further information

  • Timber tax website


  • Penn State Forestry Extension Website


  • Mike Jacobson – [email protected]