There are some important details that should be considered after timberland has been acquired. Taking care of these up front can save you time, money and headaches later on. The following is a short discussion of important tax considerations, for more detail on a specific subject follow the links in the description.
Develop and maintain in your files a management plan documenting your intention to manage the property for profit, and include an estimate of projected profit.
Why is it important to develop a management plan?
A management plan is a way to bring together all of your long-term goals and objectives. Timberland is a long-term investment and conditions can change that may alter your original plan, so it is important to be flexible when developing this plan. The plan should be developed so that it will provide guidance on how to best manage your property to achieve some desired future condition or stream of benefits.
There are several cost-share programs that are available to timberland owners to help reduce some of the costs of managing their land however, qualification for these cost-share payments is generally contingent on having a management plan that meets certain criteria.
How do you put a management plan together?
Developing a management plan can be straight forward or rather difficult, a lot will depend on your goals and objectives, the current state of the property and how that relates to some desired future condition, the size of the property, and the resources at your disposal to implement and carry out the plan.
There is a multitude of State and private consulting foresters that can help you more clearly define what your specific goals are and put them together in a management plan that is best suited for your property. These foresters can also provide advice on where to go and who to contact in your local area for help on carrying out a specific portion of your plan (timber stand improvement, timber sale, etc...).
How do you classify your timberland ownership?
The manner in which you decide to structure your timber activities, "for-profit" or "not for profit," will have an affect on what expenses are deductible and how losses are treated. This discussion is designed to give you a general overview of the different options that are available. Remember, it is the specific circumstances surrounding your timberland activities that should be considered before deciding how to classify your ownership.
Personal Use - Title to timberland is in the name of the taxpayer. Property taxes are reported as itemized deduction on Form 1040, Schedule A. The timber is a capital asset and if sold on the stump qualifies for capital gains treatment which is reported on Schedule D, Form 1040. Timber management expenses are not deductible and must be capitalized to the appropriate capital account.
Hobby - Title to the timberland is in the name of the taxpayer. Property taxes are reported as itemized deduction on Form 1040, Schedule A. The timber is a "capital asset" and if sold on the stump qualifies for capital gains treatment which is reported on Schedule D, Form 1040. Timber management expenses are deductible under the provisions of the "hobby loss rule," only to the extent of current income from the tree farm. This is because it is not held primarily for the production of income. Deductions are allowable under the hobby loss rule and are not subject to passive loss rules.
Investment - Title to timberland is in the name of the investor. Property taxes are reported as an itemized deduction. Deductible management expenses are reported as miscellaneous itemized deduction on Form 1040, Schedule A, and are subject to a 2 percent of adjusted gross income (AGI) floor. The timber is a "capital asset" and if sold on the stump the gain (loss) qualifies for capital gains treatment, reported on Schedule D, form 1040. Passive loss limitation rules do not apply to investment expenses.
Activity incidental to farm business - The timberland is titled with the other farm business property. Deductible timber management expenses are reported on Form 1040,Schedule F, if operated as a sole proprietorship. If the farmer is not holding timber primarily for sale to customers in the ordinary course of a timber business, the timber is considered a capital asset. If sold on the stump the gain (loss) qualifies for capital gains treatment, reported on Schedule D, Form 1040. If the farm business is a partnership or corporation, the timber related expenses and income are reported on the appropriate business tax form. The passive loss rules apply to the farm as a whole.
Activity incidental to non-farm business - Timberland is titled with other business property. Costs are reported on the business's tax return. Treatment of income is same as for a farm business. The passive loss restrictions apply to the business as a whole.
Active timber production business - Timberland is titled in the name of the partnership or corporation. Owners are "materially participating" in the business under the passive loss rules. Timber management expenses are reported on the appropriate business tax form. Timber is generally, but not always, held primarily for sale to customers in the ordinary course of the timber production business. Occasional sales of stumpage to outsiders may qualify for capital gains treatment under Section 1231, or capital gains treatment can be assured by disposing of the timber under Section 631(b) disposal with an economic interest retained.
Passive timber production business - The treatment is the same as for an active timber production business, except the deductibility of operating losses is restricted by the passive activity loss rules.
Timber production and utilization business - Same as active timber production business, except that timber is produced primarily for utilization by the business, not for outside sale. Any gain on timber cut for use in the business qualifies for capital gains treatment only if the requirements of Section 631(a), election to treat cutting as a sale, are met and 631(a) treatment is elected. Occasional sales of stumpage to outsiders may qualify for capital gains treatment under Section 1231, or capital gains treatment can be assured by disposing of the timber under Section 631(b), disposal with an economic interest retained
As you can see as the activity approaches the level of a "trade or business" the restrictions on the deduction of management expenses is not as great, however, the restrictions on losses increase due to the passive loss rules. It is often quite difficult for small "tree farmers" to have the regularity of income and other transactions generally associated with carrying on a trade or business.
Developing a management plan that shows a "for profit" motive with some prediction of those expected profits should be sufficient to raise the level of your activity to an investment. Thus allowing greater freedom on the deduction of management expenses, without the worries of the passive loss rules.
Establish accounts allocating as much of the available basis as possible to those assets which will be disposed of first or can be depreciated.
Capital expenditures are the costs associated with the acquisition of property or property rights. By definition capital expenditures must be capitalized. This means that it is necessary to determine the basis for each of the assets associated with you timberland acquisition and establish separate accounts to record (and adjust as necessary) the basis. It is very important that accurate and up-to-date records are maintained for your timberland.
There are three primary accounts that need to be established:
Land Account - Assets placed in the land account(s) include the land itself, nondepreciable land improvements, and depreciable land improvements
Timber Accounts - Three basic timber accounts may need to be established. These are merchantable timber, young growth, and plantation or deferred reforestation accounts. Each account should have the basis measured in dollars and the volume measured in some form of standard units.
Equipment and building accounts - Assets placed in these accounts include durable equipment such as sawmills, trucks, tractors, and power saws. Individual accounts should be established for each item or class of items.
File for property tax relief
One way to reduce some of the financial burden associated with owning timberland is through some form of property tax relief. Information on the programs that are available can usually be obtained through your consulting forester or Maine Forest Serivice about Tree Growth Tax Law.