Timber sale

[Bill Tubbs]

Thought I had this figured right, but have a new client that when we looked over last year's return, how the prior preparer handled it is making me second guess myself. I have not _yet_ done a timber sale so want to make sure I'm on the right track...

Client inherited 80 acres of woodland in 2000, and it is on the property tax roles as "Managed Forest". In 2004, 60 of those acres were select-cutted -- the local forest manager came in and decided which trees should be cut -- and clients were paid $16,000 for the trees. On the 2004 return, it was reported on Sch D: sale $16,000, basis $0. I agree with the Sch D treatment, but these trees didn't grow from seedlings in just 5 years, so my take is there should be a significant basis. That basis needs to be calculated from what the FMV was at date of inheritance, with that FMV broken out to the small cottage, land, and trees. So far so good?

Next question is what to do with the expenses of the forestland -- such as "Forestry Consulting Fees" and "Forestry Supplies"? From what I can gather, looks like Sch A subject to 2% seems to be the answer (investment expense). But, shouldn't the expenses be broken out between Sch A & Sch D? Seems to me those expenses that are directly tied to the select-cut would increase the basis on Sch D. (Of course the benefit of the expense going on Sch A vs. Sch D will vary depending on if client can itemize, and how high the 2% floor is.) For example, is the conservation warden determining which trees should be cut, a Sch A (since the decision was as much which trees to keep vs. cut) or basis adjustment for Sch D?

I tried reading through some timber sites tonight, but it seems like the mother-of-all-sites, timbertax.org, has not been available the past couple days. So any assistance would be appreciated.

Thanks,
Bill

[JG EA]

Timber

Is either a personal asset or a business asset or investment income. Decide that and the rest falls into place. Even if it is a personal asset you can do a cruise (a backwards cruise) and find the basis in the timber. There are many foresters who do this for a living. Then a Schedue T must be filed to count the basis in the trees vs. the basis in the land.

However, if the land is old (the timber was non existent at the time of purchase), or the client is disinclined to pay for a backwards cruise, then you take the zero basis and go from there.

As for the investment fees you mentioned, have you concluded this is investment income?
Remember the basis is affected for future sales (timber or the property itself). There can be no percentages used. There must be a cruise. Some experienced in timber sales do office cruises. If there is not this valuation done - then your only choice is Sch D, zero basis. If you get into other expenses then you are saying the property is investment or business property. Think ahead. Do you want it to be business or investment property for tax purposes? Does the client?

[Bill Tubbs]

Timber = investment

Is either a personal asset or a business asset or investment income. Decide that and the rest falls into place. Even if it is a personal asset you can do a cruise (a backwards cruise) and find the basis in the timber. There are many foresters who do this for a living. Then a Schedue T must be filed to count the basis in the trees vs. the basis in the land.

Have determined that the timber is an investment for this client, with sales going on Sch D, and then some maintenance can be deducted on Sch A subject to 2% as investment expense. But, especially for 2005 will be looking at how many of the expenses can be capitalized as AMT is an issue.

From the "Who Must File" on the Form T Instructions, it does not look like we are required to file Form T:
"Exceptions. You are not required to file Form T if you only have an occasional sale of timber (one or two sales every 3 or 4 years). However, you must maintain adequate records of these transactions...."

However, if the land is old (the timber was non existent at the time of purchase), or the client is disinclined to pay for a backwards cruise, then you take the zero basis and go from there.

Land and standing timber were inherited in 2000. Client says trees are at least 100 years old, so their basis should be pretty close to what they sold for. Paying someone to do a cruise would certainly be the easy way to determine the basis, but IF clients decide they could estimate based on nearby sales, wouldn't that be acceptable? I know, the density, type, and age of trees would all be factors, so to find identical property would be exceedingly difficult. I will be pushing client to obtain a basis somehow, preferably from a cruise.

Remember the basis is affected for future sales (timber or the property itself).

Exactly. They had a timber sale in 2004, and then a timber theft in 2005, and who knows what else they'll have in the next few years. If they have a cruise done, it will help them out immediately for 2 tax years. And, their plan is to let their kids inherit the land (in 20-30 years), so the more basis that can be assigned to the timber, that will help out their overall tax planning.

In 2005 client purchased a tractor and erected a garage for it. Presuming it is for maintaining the property, how do you propose to account for it? Depreciation on Sch A as investment expense?

Thanks,
Bill

[JG EA]

I have

I have done just that for investment expenses on A subject to 2%. Just be sure of the business percentage - ask enough questions.

[Snaggletooth]

Schedule F

Bill, the investment in this land was by its own appellation, timber property.

Thus the whole thing should be reported as a Schedule F sale of products raised. I know this deprives the seller of capital gains, but it also allows for full deductibility of all the expenses you mentioned -- not just in this year but in EVERY year. This is a timber OPERATION and not a timber INVESTMENT, based on the facts you have given.

Land taxes and applicable interest (with no ceiling) are deductions, too. As well as liability insurance, applicable mileage, legal and selling expenses, etc.

Just my opinion...Good luck!

[Jesse]

In 2005 client purchased a tractor and erected a garage for it. Presuming it is for maintaining the property, how do you propose to account for it? Depreciation on Sch A as investment expense?

Thanks,
Bill

Thinking about Snaggletooth's reply and where the deductions would go, wouldn't it depend on how much work is being done by the investor? Is he making it a business by material participation w/ his tools and equipment? Or another party harvesting the timber?

With the Section 631 election can't you take the expenses against your income and the income is treated as capital gains?