Timber Taxation for Forestland Owners CLINT BENTZ CPA
Timber Taxation for Forestland Owners CLINT BENTZ, CPA, CMA BUSINESS NAVIGATORS, LLC 38620 LULAY RD SCIO, OR 97374 CLINT@BISNAV. COM Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 1
Overview of Course (Seven Weeks) March 9: March 23: March 30: April 13: April 27: May 11: May 25: Overview of Timber Taxation & Deducting Casualty Losses How You Are Classified Determines How You Are Taxed Reporting Income Deducting Expenses Capital Expenditures Choosing a Form of Business and Other Tax Issues Understanding Oregon’s Property & Harvest Tax Programs Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 2
Week 3 Outline §Capital Gains Treatment §Sale of Land & Timber Together §Sale of Easements (including conservation easements) §Lump Sum Sales (a. k. a. timber deeds) § 1031 Exchanges of Timberland Timber Deeds §Pay as Cut Contracts IRC 631(b) §Sales of Logs §IRC 631(a) – Election to Consider Cutting as Sale or Exchange §Sales of Firewood and other Forest Products Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 3
Capital Gains Treatment §Capital gains are taxes on the sale of capital assets §No self-employment taxes on capital gains §Capital gains can be offset by capital losses §Capital gains do not reduce social security benefits §Investment and passive business income subject to NIIT Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 4
Capital Gains (2020) – Why Care? Ord % CG% MFJ Brackets Single Brackets Trusts 10% 0% 0 – 19, 750 0 – 9, 875 0 – 2, 600 12% 0% 19, 751 – 80, 250 9, 876 – 40, 125 – 22% 15% 80, 251 – 171, 050 40, 126 – 85, 525 – 24% 15% 171, 051 – 326, 600 85, 526 – 163, 300 2, 601 – 9, 450 32% 15% 326, 601 – 414, 700 163, 301 – 207, 350 – 35% 15%* 414, 701 – 496, 600 207, 351 – 441, 450 9, 301 – 12, 950 35% 20%* 496, 601 – 622, 050 441, 451 – 518, 400 37% 20% 622, 051+ 518, 401+ 12, 951+ 5
Sale of Land Timber Together §Generally, standing timber considered part of real property §Recapture if reforestation deductions taken in last 10 years §Timber and land as part of personal residence §Report on Sch D or Form 4797 §Deduct cost basis including remaining depletable basis plus expenses related to the sale Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 6
Sales of Easements §Sale of permanent easement is treated as real property § 3 options for recovery of cost basis § Treat easement as leasehold and do not allocate basis § Treat easement as sale of land affected by easement and apply pro-rata share of basis to fraction sold § Treat as open-ended sale (or easement affecting entire property) and recover cost basis against sales price dollar for dollar Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 7
Conservation Easements §Three basic forms: § Donation (charitable deduction for decrease in FMV from easement) § Sale for FMV (treated as a sale of real property – see previous slide) § Bargain sale (sale for less than FMV) §If bargain sale, basis must be allocated between the sale amount and the charitable gift based on IRS regulations for bargain sales Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 8
Lump Sum Sales (a. k. a. Timber Deeds) §Most timber in Oregon is sold under timber deeds. Mills purchase open market logs to meet excess demands. §Defined as outright sale of standing timber for fixed price §Written for a specific term and can contain other provisions §Title passes to buyer at signing, seller has no risk of loss §Payment in a lump sum up front or installments over time §Depletion amount based on volume of standing timber sold §Sales expenses can be added to depletion amount Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 9
1031 Exchanges of Timberland § 1031 exchanges defer realized gains into new property §TCJA 2017 eliminated personal property from IRC 1031 §Both relinquished and replacement properties must be held for investment or productive use in trade or business §All US real property, improved and unimproved is like kind §Standing timber is included in real property definition §Beware of tracking requirements for out-of-state purchases Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 10
1031 Exchanges of Timber Deeds §The IRS has generally not treated the exchange of timber separate from the land as like-kind to a fee interest in real property, but rather as an income interest in the property similar to a leasehold interest §Leasehold interests with more than 30 years yet to run are considered like-kind to a fee interest in real property §Therefore, most tax practitioners treat unrestricted timber deeds of more than 30 years as qualifying as like-kind to a fee interest in real property Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 11
1031 Mechanics §Gain realized on sale of the sold (relinquished) property is deferred to the extent that: § The purchase price of the replacement property equals or exceeds the sales price of the relinquished property; and § The debt on the replacement property equals or exceeds the debt on the relinquished property §Cash received and debt relief are considered boot and are taxable. No cost basis is allocated to boot unless boot exceeds the realized gain. Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 12
1031 Mechanics §The exchange does not have to be simultaneous §Sales proceeds from relinquished property are placed in qualified 1031 exchange escrow account §Seller has 45 days to identify replacement properties §Seller has 180 days to close on replacement properties §Seller may not file tax return until 1031 exchange completed §Can acquire replacement property up to 180 days prior to sale of relinquished property in “reverse” exchange. §Exchange reported on Form 8824 – Like-kind Exchanges Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 13
Pay as Cut Contracts IRC 631(b) §Taxpayer sells standing timber, is paid as timber is removed §Title transfers at sale, seller retains risk of loss §U-Cut Christmas tree operations §Property must be held more than 1 year (IRC 1231 requirement) §Date of disposal is the date timber is cut §Reported on Form 4797 – Sale of Business Property §Sale expenses can be added to depletion amount Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 14
Sales of Logs §Logs are personal property, not real property. They generally are not considered an IRC 1221 asset so sale not a capital gain. §Personal-use and hobby taxpayers report as other income on 1040 net of depletion, harvest and sale costs. NO LOSS ALLOWED. Can elect 631(a). §Investors report as other income on 1040 net of depletion, harvest and sale costs. Can deduct loss. Can elect 631(a). §Businesses report gross income on Schedule C and deduct depletion, harvest and sales costs as COGS. Can elect 631(a). Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 15
IRC 631(a) – Election to Consider Cutting as Sale or Exchange §Can be elected by any type of taxpayer regardless of classification or entity type. §Election subjects sales to IRC 1231 – hold more than 1 year §Christmas tree growers are eligible if cut trees over 6 yrs old §Election treats taxpayer as having two separate businesses – growing timber and selling timber products (logs) §Log seller purchases standing timber from timber grower §Deemed stumpage sale of harvested logs is valued as of Jan 1 Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 16
How IRC 631(a) Works TIMBER OWNER – FORM 4797 LOG SELLER – SCHEDULE C (OR F) Sales price = Stumpage value of harvested timber @ Jan 1 Cost basis = Depletion on timber harvested Net = IRC 1231 capital gain reported on Form 4797 Sales price = Gross mill receipts COGS = Stumpage value @ Jan 1 plus harvest and sales expenses Operating expenses are deducted if a business taxpayer. Net = Ordinary income reported on Schedule C (or F if activity incidental to farming operation) Not self-employment income for nonbusiness taxpayers Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 17
How IRC 631(a) Works §The deemed stumpage sale of harvested timber at Jan 1 is a valuation exercise. Burden of proof is on the taxpayer. § 631(a) gain is recognized in year timber is first measured § 631(a) cost is deducted in year cash is received for logs §Must make a proper and binding election (Form T or statement) §Stumpage value for Christmas trees is value at beginning of year, i. e. last year’s value based on size on Jan 1. Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 18
IRC 631(a) Example §Facts: § Sold 300 MBF of logs to mill for $250, 000 § All log sales proceeds received in current year § Total stand volume in year of sale is 500 MBF § Depletion basis = $24, 000. Depletion unit = $48/MBF ($24, 000/500 MBF) § Logging, hauling and sales costs = $85, 000 § Appraised stumpage value of 300 MBF harvested as of Jan 1 = $175, 000 Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 19
IRC 631(a) Example – 631(a) Not Used §Form 1040 or Schedule C/F depending on classification §Mill receipts §Depletion (300 MBF x $48/MBF) §Logging, hauling and sales costs $250, 000 §Net ordinary income reported $150, 600 (14, 400) (85, 000) Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 20
IRC 631(a) Example – 631(a) Used §FMV of stumpage at Jan 1 $175, 000 §Depletion (300 MBF x $48/MBF) (14, 400) §Capital gain reported on Form 4797 $160, 600 §Mill receipts from log sales §FMV of stumpage at Jan 1 §Logging, hauling and sales costs §Ordinary loss reported on Sch C/F $250, 000 (175, 000) (85, 000) $ (10, 000) Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 21
Sale of Firewood and other Products §Sale of firewood and other forest related and value-added products is the sale of personal property. It would be treated the same as a sale of logs. §Taxpayers can elect 631(a) based on the FMV of timber downed or harvested for firewood or other forest products. §Taxpayers can deduct depletion for timber downed or harvested for firewood or other forest products. Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 22
Questions? Clint Bentz, CPA Business Navigators, LLC 38620 Lulay Rd Scio, OR 97374 (503) 580 -0297 clint@bisnav. com Copyright © 2021 Business Navigators LLC, Unpublished, All Rights Reserved 23
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