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Income Tax Provisions for Forestry Operations

Income Tax Provisions for Forestry Operations. Lloyd R. Casey Casey’s Forestry Concepts. ITEMS TO CONSIDER. Timber is long term Being in the timber growing business Capital Income advantages Most sellers either: Pay tax on gross receipts (foolish)

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Income Tax Provisions for Forestry Operations

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  1. Income Tax ProvisionsforForestry Operations Lloyd R. Casey Casey’s Forestry Concepts

  2. ITEMS TO CONSIDER • Timber is long term • Being in the timber growing business • Capital Income advantages • Most sellers either: • Pay tax on gross receipts (foolish) • Pay no tax (unlawful)(1099s will be required for all sales) • Establish “profit motive”

  3. Needed for Return Preparation • Timber management Plan, to include: • acquisition volume (bd. Ft; cords; tons;etc) • value at acquisition • schedule of operations • growth rates & mortality • maps (stands, boundaries, acres, roads,etc) • Acquisition Expenses

  4. Needed for Return Preparation (con’t) • Land Evaluation • Timber sales information: • price per unit (mbf; cords; tons) • harvesting contract • sales expenses(advertising, commissions, etc) • forester expenses • legal fees

  5. Needed for Return Preparation (con’t) • Capital Expenses • roads • fire lanes • buildings • tree planting • Forms • Form T; Form 1040, parts 1,2,3

  6. How to Figure Basis • Items needed • fair market value of the land • fair market value of timber • fair market value of brushland • fair market value of young growth • Set each item as percent of total

  7. How to Figure Basis (con’t) • Set up original cost basis to include all acquisition costs such as: • lawyer fees • closing costs • forestry appraisal • survey costs • Use percent of each item and multiply thetotal resulting in a new allocation of basis

  8. Situation The 19 acre woodland and 3.6 acres of pipeline was purchased in 11/26/03 for $70,000. The legal fees were $3,084 Surveying and other acquisition expenses were $12,325 for a total of $85,409. The Fair Market value of the land was $3,097.35/ acre or $70,000 and the fair market value of the timber was $42,650 or $282.45 /MBF (151 MBF). The cruise determined that the annual growth was 6.8% A road was built for access at $4,240 A sale was conducted and 50.5 MBF was sold for $15,148. Sales costs were $2,272.

  9. Basis Reallocation Cost basis reallocation ASSETS FMV Percent of total Land 62% $70,000 $53,700 $32,722 $42,650 38% Timber Total $116,890 100% $85,409 $76,000

  10. Basis Reallocation Cost basis reallocation ASSETS Cost Percent of total $52,954 Land $43,400 62% Road $4,240 $32,455 $26,600 38% Timber Total $70,000 100% $89,649 $76,000

  11. Setting Up The Books • Keep it simple • Keep records by forest stands • For each record: • Basis (per unit- MBF, cords, or tons) • Capital Expenses, ordinary expenses by date • Income by date • Management Hours (diary) • Taxes paid

  12. Setting Up The Books (con’t) • Accounts by Management Unit such as: • Land • Buildings • Mature Timber • Reforestation area • Young stands

  13. Passive Loss Rules(Three Kinds of Income) • Active Activity - Timber held as part of a trade or business • All management costs, taxes interest payments are fully deductible from any income source • Losses can be carried back 2 years or forward up to 20 years • Or expenses can be can be capitalized (deducted at time of sale) • In order to be eligible, the owner must materially participate in the management of the business. • Eligible for Section 179 deductions

  14. Passive Loss Rules(Three Kinds of Income) (cont’t) • Material Participation means it must be: • REGULAR - consistent or habitual in nature • CONTINOUS - ongoing • SUBSTANTIAL - considerable, ample, large • Material participation includes: • All work done by individual and spouse • Work done as an investor does not count

  15. Passive Loss Rules(Three Kinds of Income) (cont’d) • Passive Activity - timber held in a trade or business in which taxpayer does not materially participate • Management expenses are deductible only to the extent of all passive income • Taxes - as above • Interest - as above • Allowed to capitalize all expenses

  16. Passive Loss Rules(Three Kinds of Income) (cont’t) • Passive Activities include: • Any activity without material participation • Any limited partnership • Any relationship with a consultant who makes all of the management decisions • When passive activity is disposed of, losses and those that have been carried forward can be deducted from any income source

  17. Passive Loss Rules(Three Kinds of Income) (con’t) • Investment or Portfolio Activity - Those activities where there is an investment, but no significant management activity • Individuals and other non-corporate taxpayers can deduct management costs above a 2% floor • Expenses can be capitalized • Taxes are deductible from any income source • Interest -deductible up to investment income • Excess expenses may be carried forward

  18. Passive Loss RulesTests for Active Participation • Must participate at least 500 hours per tax year • Owner’s participation constitutes all participation • You must participate at least 100 hours and is more than any one else • Participation in all “significant activities” is more than 500 hours • Owner must materially participate for 5 of preceding 10 years • If all the facts and circumstances so indicate, then you materially participate (No rules issued)

  19. Summary of Deductibility by Income Activity Investment (Portfolio) Business Passive Business Active Type of Expense Deductible against passive income,only Management Expenses Deductible beyond 2% floor Deductible from all income sources Deductible against other income Property tax & others Same as above Same as above Interest Deductible to extent of investment income +$10M Same as above Same as above

  20. Advantages of Capital Gains • Top Bracket is 15% vs 35% for ordinary income. Under $10,500 in 08- no tax • Social Security Taxes are not paid on Capital Grains • Capital Gains income does not affect Social Security Income • CG income can be utilized to offset capital losses whereas only $3,000 of ordinary income can be used for that purpose

  21. What are Capital Assets? • Section 1221 - Any and all property held by the taxpayer (whether or not connected with his trade or business) except: • Stock in trade, inventoriable property, property held for sale to customers in the ordinary course of trade or business • Real property used in trade or business • This provision is for those in investments

  22. What are Capital Assets? • Section 1231 -Real property held for more than one year that is used in business is eligible for capital gains treatment • If a series of transactions result in a gain, they are eligible for capital gains • If a series of transactions result in a loss, each transaction result is an ordinary gain or loss • This provision is for those in the “timber growing” business

  23. Timber Sales Provisions • Timber held as an asset in a trade or business with active participation in management (631a) • Can elect to sell or exchange • Available to those in the “timber growing business” • Must cut timber for sale or use in one’s trade or business

  24. Timber Sales Provisions (con’t) • Realizes gain or loss equal to difference between timber’s Fair Market Value (FMV) on the first day of the tax year of the cut and adjusted for the basis • FMV thereafter becomes the cost of timber in computing inventory • The difference in FMV of standing trees and felled timber is ordinary income

  25. 631a - Timber Owner in the Business(Must make election)* * New law gives one-time option to get out of election without IRS approval Jan. 1

  26. Timber Sales Provisions (con’t) • Timber sold using a contract (631b) • Must retain economic interest in timber until it leaves the property • Must own for one year • Must be in the business • Not an elective provision, operates independent of 631a, but may apply together

  27. Timber Sales Provisions (con’t) • This provision has been changed!!!!!!!! • You no longer have to retain economic interest. • You no longer have to sell with a cutting contract. • Those in the business can sell “lump sum” • As before a 1099-S is required ( All timber sales will require a 1099-S in 2009) • For those wanting to sell on shares- all income is ordinary income.

  28. Reforestation Amortization • Must be an individual landowner • The first $10,000 is fully deductible in the first year. • All expenses above $10,000 are amortized over 8 years • Christmas trees, ornamentals, shelter belts and nut orchards are not eligible • Includes all costs for establishment • Replanting costs for drought are eligible • Establishment costs can be incurred over 2 years

  29. Reforestation Amortization (con’t) • Costs for natural regeneration are eligible • Land must be located in US on one acre or more • Use Part 4 on Form T, Form 4562. Then report on Form 1040, adjustment to income on Schedule C or F • There are recapture provisions for up to 20 years

  30. Reforestation Tax Credit • The tax credit has been lost!!!!

  31. Exclusion of Cost-share Payments • Provides for all or part of approved gov’t cost-share program payments to be excluded from taxes • Programs must be approved by USDA that they protect soil and water and conserve forests • They must not contribute significantly to the income of the property • Subject to recapture if sold within 10 years • TSI payments cannot be excluded, but expensed

  32. Exclusion of Cost-share Payments(continued) • If income was received in the last 3 years: • Average for the 3 years • Multiply by 10% • Divide by Interest Rate (No IRS guidance) • If your answer is more than the payment, all is excludable • If it is less, only the amount in your answer is excludable

  33. Exclusion of Cost-share Payments(continued) • If there is no income, use $2.50/acre of area treated divided by the interest rate • Follow the same procedure when income is received. If your answer is larger than the cost-share, all is excludable. • In both instances, explain your calculation and why you used your interest rate.

  34. Exclusion of Cost-share Payments(continued) • For those who report as investors: • Report as “miscellaneous income” on front of 1040 • For those in the timber business: • Report on Schedule C on form 1040 • For Farmers: • Report on Schedule F on 1040

  35. Gun Tax • The NRA has reported tht each tax payer is to report the number of guns in ownership. • Then there would be a $50 tax on each gun. • That the provision was snuck in on a bill that every one wanted and they didn’t see it. • This is a totally false roomer. The was something suggested during the Bush administration in 2002, but it went away.

  36. For Further Information Contact: Lloyd R. Casey Casey’s Forestry Concepts 1263 Palomino Drive West Chester, PA 19380 Phone: 610-436-9424 Email: lcasey@comcast.net Web Site: caseysforestryconcepts.com

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