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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 Considerations for Forest Landowners

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tax considerations for forest landowners

Tax Considerationsfor Forest Landowners

Mike Jacobson

School of Forest Resources

Penn State

Nov 11, 2008

PSU Webinar

  • 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.
  • 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
types of forest taxes
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)
  • Establishing basis
  • Expenses
  • Timber Income
  • Other tax considerations
  • Estate planning
  • Conservation easements
establishing a basis
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
original basis
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
original basis8
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
adjusted basis
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
expenses advantage of being in the business
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
passive loss rules the three categories
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
operating expenses and carrying charges
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
timber income
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)
type of income is important
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
qualifying for capital gains
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,
reforestation amortization and deductions
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
cost share payments
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!
involuntary conversion
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
court cases last 10 years
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
record keeping
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
estate planning forestland issues
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
three common phrases
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
federal estate tax applicable exclusion 26 u s c 2010
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

pa inheritance tax rates
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
tools and strategies
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
tax planning opportunities with conservation easements
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
tax benefits from donation of easement
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.
  • 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!
further information
Further information
  • Timber tax website
  • Penn State Forestry Extension Website
  • Mike Jacobson –