Invol Conv of Timber Land

[erchess]

A client owns tree farms in two states. This question concerns the one in NC. The tree farm was inherited in the 60s and had been personal use property in the hands of the decedent. I do not know when it was converted to a tree farm. Now Progress Energy wants right of way to a little over an acre of the land and they have said they will go to court and use eminent domain if the taxpayer balks at their offer of 275K for the right of way. Note that they will not be buying the land in fee simple but only obtaining the right to clear the land put up power lines and go on the land for the purpose of maintaining the power lines whenever they wish and without prior notice or consent. The taxpayer has had a professional appraisal done and the conclusion is that the value of the rest of the land is not diminished by this and that the price offered is a fair estimate of the present value of the timber. He is also having his attorney review the contract to be sure he really understands the terms and he is getting everything a court would be likely to grant him if he fought the company. He wants to sit down with the tax guy he recently hired (yours truly) next week to be sure he understands what this is going to do to his tax return.

I would think that basis would be fair market value at the time of death or alternate valuation date, right? The taxpayer still has the will in question and the papers resulting from a professional appraisal done within a couple weeks of the death.

Second are we going to have ordinary income (Sch F?) or capital gain income? The client is hoping for capital gain treatment but I don't see how. He is going to give me some pubs from the US Forest Service and a professional organization for tree farmers.

I will read the pubs he gives me. I will read TTB beginning on 6-12 and 14-7 and the IRS Pubs referenced there. Can anyone suggest anything else I should read? I have as much time as I need to read whatever and just like the rest of you when I take a guy's money I want to be sure I am doing the job right. I know some heavy preparation is involved because I have not done this sort of thing before but hey I know how to read tax information and I have time so I feel like I can nail this but pointers from yall would be appreciated. Thank you in advance.

[Burke]

I believe this will be treated as the sale of an easement. The cost basis of the original land is reduced by the sales price of the easement. If the basis is less than the sales price, the owner has a Schedule D gain on the difference. If not, there is no gain on the sale of the easement.
See Treasury Reg Sect 1.61-6(a) which covers this. "When a part of a larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among the several parts......the sale of each part is treated as a separate transaction, and the gain or loss computed separately [at the time of sale.]

There are two methods of determining basis. See https://www.landreport.com/2008/04/t...-on-easements/
See also Revenue Ruling 77-413 and 77-414.

[Burke]

I would think that basis would be fair market value at the time of death or alternate valuation date, right? The taxpayer still has the will in question and the papers resulting from a professional appraisal done within a couple weeks of the death.

Yes, you are correct. In this case, basis is FMV when inherited at DOD, not original cost. If the sale of the easement does not adversely affect the rest of the land, then allocate basis per acre and go from there.

[erchess]

Further questions

First of all thank you Burke. Now for you or anyone else, let's be sure I understand things.

The original tract of land plus a house was inherited. I know total FMV at the time and it may be that land value vs house value was determined at that time. If not, I don't yet have enough information to determine that or even ask questions here. However, it is clear that the taxpayer will have a gain since the price for the easement is almost 300K and total basis is a little over 2K. As the taxpayer says it's almost not worth calculating basis. Anyway we'll have a gain on 4797 carried to Sch D.

So, do we have the option of declaring basis to be immaterial and not changing his basis in the tract? If we did that what would be the basis in the "eased" land if the tract was not sold in its entirety? Also is there any way we can increase basis in the property by the easement sale price or the gain on the easement? I didn't think so but I thought I would ask.......

[Burke]

So, do we have the option of declaring basis to be immaterial and not changing his basis in the tract? If we did that what would be the basis in the "eased" land if the tract was not sold in its entirety?

Not sure I understand exactly what you mean by "if the tract was not sold in its entirety?" The easement will be specified by acreage or footage or whatever in the sales contract. If you allocate the original basis by acreage, then you just apply that to the portion "eased" to determine your gain. I do not think it matters if you ignore this calculation and declare the entire easement payment as taxable gain with zero basis if you want. Then the original basis stays with the remaining property. You would not add the sale price or gain to the property basis. Usually assessors and/or appraisers break down the value of land and house separately so this should not be a problem.

[erchess]

Burke

Sorry to be unclear.

If the taxpayer goes through with the easment, he might at some future point sell some but not all of the property. I flatter myself that I know what his basis in the whole would be if he sold the whole, but I don't know what his basis would be in the part subject to easement if he sold only some of the property. I am thinking basis in the part subject to easement would be zero unless I set some basis aside and don't use it in calculating the tax consequences of the easement.

Another question - we all know that certain fairly common events can increase basis in a structure and that certain possible events such as adding a camper top might increase basis in a truck but are there any events that would increase basis in a tree farm? The only thing I can think of would be if there was a special assessment for some purpose such as road widening. Anything else I should quiz him about?

[Burke]

When property is sold that includes a previously granted easement, that easement goes with the property. Gain is recognized on the portion designated as the easement when that easement is granted and payment is received. If you do not allocate basis to it at that time, the original basis would remain with the unsold property. If part of the property not including the easement portion is sold at a later date, you would have the same option again. You can allocate the basis to the sold portion to reduce your taxable gain. Or not, and pay tax on the sale at zero basis. Why would you want to, however, unless you think he may sell in a future year when cap gains probably will be higher, or he has other significant income coming in that might trigger AMT, or some such strategy. He may die before that occurs, and the basis would have been wasted. I would allocate basis on the easement, and on any future partial sale of the property as well.

Ex: Total Acreage = 500. Acreage granted for easement = 10 acres. Ratio = 2%.
Original Basis = $100,000. Amount allocated to easement = $2,000.
Remaining Basis = $98,000.

200 Acres sold later = $98,000 divided by 490 = $200 per acre (same as original tract).
Basis allocated = $40,000. Remaining basis is now $58,000 for 290 acres. (Still $200 per acre)

[erchess]

TYVM Burke

I appreciate all the help.

[Edsel]

Date of Death

Erchess, when was the date of death? The OP states it was inherited back in the '60s, but after reading further I might get the idea that there was yet another death and accession of property.

This gives rise to two vastly different tax problems. If inherited in the '60s, the basis would be a pittance compared to today's values. Additionally, the elapsed time exceeds the maturity cycle for some species of timber, notably most pines, thus demolishing any meaningful estimate of timber value from that long ago.

I'm also wondering if under the doctrine of involuntary conversion, the sale can be reported as a reduction in basis of the remaining acreage, rather than having to claim capital gains.

If you are forced into capital gains, and your client is apparently not going to prevail in court, I would advise him to get a contract for sale finalized by the end of 2010. I'm told it is almost imminent that CG rates are going up in 2011.

[erchess]

OK I misunderstood some things

Yes the land in question has trees on it but they have never been harvested and there are no plans to harvest from this tract, on which sits the home in which TP and S reside. She inherited the house and the land in the late 60s. It was built in the 30s as an unheated and uncooled summer place and I am not yet clear whether air and heat were installed before or after she inherited the place.

As I said there is timber on the place but it isn't worth much and neither taxpayer nor I is comfortable calling the land a business property.

We do plan to close the deal in 2010 and I am thinking Sch D without 4797.

There is some land outside the easement which the contract says Progress Energy can trim or remove anything above a certain height. Taxpayer is working on getting this modified so that one hundred year old tree will only be topped and shaped rather than being felled. The contract explicitly states that the taxpayer is not entitled to get and will not get any consideration for this loss of use of land beyond the easement. When I was thinking the land was a tree farm I was thinking of this as a business casualty and of the expenses of planting in the involved spaces plants PE would not object to as ordinary and necessary business expenses. Now I am thinking personal casualty (lost to the AGI haircut) and personal expenses (never deductible).

Plans are to have son inherit the property so we want to use what basis there is

What am I overlooking>

[JON]

Burke

did a good job, but why would you not harvest the trees before the easement? Unless the authority is assigning value to the trees, then you are ahead to do it in one transaction. My guess is your easement payment will be in excess of the basis and all subsequent sales will have 0 for a basis if that is the case.

[FEDUKE404]

Trees and basis issues

My head is spinning here - but I will take this as a learning experience from those with far more knowledge than my own.

Thought #1: Assuming the trees, easement or otherwise, are sold, I thought it was generally accepted that such trees had a zero cost basis. IF the person was a (certified) tree farmer, and had incurred expenses over the years specifically to plant/raise those trees, those costs could be considered. OTOH, except for certain (limited) expenses most folks would have already amortized those expenses along the way using the "reforestation" 7-year option. End result: likely still a zero cost basis for the trees.

Thought #2: If all the property owner is selling is an easement (and not the property itself unless eminent domain issues occur), I would be hard pressed to consider any cost basis in the LAND itself to be an issue for the mere easement sale.

Thought #3: At one time, there were some very knowledgeable folks in the Forestry Department of NC State University who would offer advice/resources to help in matters such as this.

As I said - I will follow this thread for more input! Stay cool this weekend.

FE

[Burke]

A true tree farm in which timber is grown and harvested can claim percentage depletion based on a value which must be determined by appraisal when the land is purchased. The appraisal must estimate the total board feet which is on the property as a whole. As timber is harvested, depletion is claimed on the sale of that timber based on the board feet sold. However, this is not the case here. Any sale of timber prior to easement would be a sale at cap gains rate, no basis. However, the sale of an easement is different, since this is the permanent sale of a right, and you could allocate basis.