Brad? 1099-s

[SueBaby]

I have a client that cut timber off his land that was inherit by his father (that died) in 1986.
He cut the timber off it last year and sold it for $10946.

The client says the land was worth $10,000 back then and he put $1,000 in a survey.

My question is: Do I put $11,000 in cost and then the sell of course the $10946? That would make a $54 loss, if that is correct.

Any suggestion on this matter? (and I don't know what it is worth today).

Looked on page 5-28 on TTB, and page 3-19, but don't know if that applies to my client.

Can you explain---please?

THANK YOU VERY MUCH

[Brad Imsdahl]

TTB, page 5-28 says you start with basis, which in your case is $10,000 for the inherited land plus $1,000 for the survey.

Then it says from this amount, subtract all of the following:

1) Amounts recoverable through deprecation....(should be zero)

2) The residual value of land and improvements at the end of the operations.

3) The cost or value of land acquired for purposes other than mineral production.

Forget about number 1 and 3 above. Lets illustrate how number 2 works.

You start with the basis of $11,000, and then subtract the residual value of land at the end of the operation. In other words, what is the land worth once all trees are stripped off?

Let's assume the bare land with no trees left on it is worth $8,000 today. That means your basis for depletion can be no more than $3,000 ($11,000 minus $8,000).

Now let's assume the bare land with no trees left is worth $15,000 today. That means your basis for depletion is zero ($11,000 minus $15,000 is less than zero).

Once you have figured the basis for depletion (if any), you divide that basis into the number of total units (trees) that could be cut at the beginning of operations. The example on page 5-28 illustrates how to figure the depletion amount once you have determined all of these amounts.

[Ron]

Not to disagree with an author on my first post, but I believe this is how this should be handled. First I am assuming the client inherited the land in 1986. The basis in this timberland would be composed of two parts at that time:

1. The FMV of the raw land at the time of inheritance plus the cost of the survey. (Assuming this was strictly a property line survey not any sort of forest management plan)

2. The FMV of the standing timber at the time of the inheritance.

In the current year, at the time of harvest, a depletion rate would be calculated by dividing #2 above (the 1986 FMV of the standing timber which is the basis in the standing trees) by the total timber volume on the land. This depletion rate is then multiplied by the timber volume harvested in the tax year to determine the total depletion taken against the $10946 received in stumpage income. This calculation would be detailed on Form T attached to the 1040.

[Brad Imsdahl]

IRS Pub 225 page 50 (2005 version) says you use cost depletion for Timber. The first step to figure cost depletion is to determine your adjusted basis of the timber on hand at the beginning of the year. The Pub refers you to chapter 10 of IRS Pub 535 to determine the basis for cost depletion. If you have no basis at the beginning of the year, there isn’t going to be a depletion deduction.

Pub 535, page 38 (2005 version) says to figure the basis for cost depletion, you have to subtract out the residual value of land at the end of operations.

The key here is the fact that the residual value of land can increase over time. If the taxpayer had acquired the land in 1986 and then proceeded to cut the timber in that year, the residual value of land at the end of operations in 1986 would more than likely be less than the beginning basis in that land. Thus, there would be a basis for depletion.

But when you wait 20 years before you even begin to cut timber, the residual value of land at the end of operations is more than likely going to exceed your original cost basis, thus, no basis in depletion.

The key here is the basis for depletion in 1986 is not the same as the basis for depletion in 2006, because of the requirement in cost depletion to subtract out the residual value of the property at the end of operations.

[xgflek]

We need to keep in mind that there are two separate accounts/properties here. There is a land account and a standing timber account which may or may not be separated into further accounts such as merchantable timber, premerchantable timber, etc. The land is separate from the standing timber and any gain on the land is only dealt with when the land is sold it does not affect the standing timber's basis for depletion. I have listed a link to information on timber tax issues (http://www.timbertax.org/publications/TaxTips2006.pdf). IRS Publication 225 page 46 details the timber depletion calculation and you will see that in calculating the depletion unit the adjusted basis or cost of the timber is used for the calculation the strict "cost depletion basis" method Brad described is not used as the land is not part of the standing timber and is a completely separate property that can not be depleted. (Unless you happen to also have mineral property in your land, but that would be a whole new ballgame.)

[Brad Imsdahl]

IRS Pub 225 says:

Timber Depletion

Depletion takes place when you cut standing
timber (including Christmas trees). You can fig-
ure your depletion deduction when the quantity
of cut timber is first accurately measured in the
process of exploitation.

Figuring the timber depletion deduction.

To figure your cost depletion allowance, multiply
the number of units of standing timber cut by
your depletion unit.

Timber units.

When you acquire timber
property, you must make an estimate of the
quantity of marketable timber that exists on the
property. You measure the timber using board
feet, log scale, cords, or other units. If you later
determine that you have more or less units of
timber, you must adjust the original estimate.

Depletion units.

You figure your depletion
unit each year by taking the following steps.
1. Determine your cost or the adjusted basis
of the timber on hand at the beginning of the year.
2. Add to the amount determined in (1) the
cost of any timber units acquired during
the year and any additions to capital.
3. Figure the number of timber units to take
into account by adding the number of tim-
ber units acquired during the year to the
number of timber units on hand in the ac-
count at the beginning of the year and then
adding (or subtracting) any correction to
the estimate of the number of timber units
remaining in the account.
4. Divide the result of (2) by the result of (3).
This is your depletion unit.

You will note that Pub 225 says in step 1 that you must first determine your cost or adjusted basis in the timber on hand at the beginning of the year.

You will also note that it says timber depletion must be done under the cost depletion method.

On that same page in IRS Pub 225 under Cost Depletion, it says:

Cost Depletion

To figure cost depletion you must first determine
the following.
1.The property’s basis for depletion.
2.The total recoverable units of mineral in
the property’s natural deposit.
3.The number of units of mineral sold during
the tax year.

You must estimate or determine recoverable
units (tons, barrels, board feet, thousands of
cubic feet, or other measure) using the current
industry method and the most accurate and reliable
information you can obtain.

Basis for depletion and total recoverable
units are explained in chapter 10 of Publication
535.

You will not that under this paragraph, board feet is mentioned in connection with recoverable units. Board feet is a term used in the timber industry, so this paragraph does apply to timber depletion.

You will also not that you are to refer to IRS Pub 535, chapter 10 to determine the basis for depletion.

IRS Pub 535, chapter 10 under Timber depletion repeats what is said above in IRS Pub 225. On page 42 of the 2005 version, it says:

“Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property.”

On page 38, under the discussion on Mineral Property, the discussion on Cost Depletion is as follows:

Cost Depletion

To figure cost depletion you must first determine
The following:
1.The property’s basis for depletion.
2. The total recoverable units of mineral in
The property’s natural deposit.
3.The number of units of mineral sold during
the tax year.

Basis for depletion.

To figure the property’s
Basis for depletion, subtract all the following
from the property’s adjusted basis.
1. Amounts recoverable through:
a. Depreciation deductions,
b. Deferred expenses (including deferred
exploration and development costs),
and
c. Deductions other than depletion.
2. The residual value of land and improve-
Ments at the end of operations.
3. The cost or value of land acquired for pur-
poses other than mineral production.

Again you will note that the residual value of land at the end of operations is mentioned and is a key element in determining the adjusted basis of timber for cost depletion.

Nowhere in any of these IRS Pubs does it allow you to separate the timber and the land into two assets and ignore the residual value of land rule.

Unless you want to argue that IRS Publications are simply wrong or poorly written.

[xgflek]

As indicated in your last place "1. Determine your cost or the adjusted basis
of the timber on hand at the beginning of the year.)" you use the adjusted basis for calculation of the depletion rate and it is the adjusted basis as defined in Pub 535 Cost of depletion Adjusted basis that you noted, which definition is below. For mineral rights you then modify the adjusted basis as you indicated but as is clearly spelled out in Pub 535 and Pub 225 you use the adjusted basis.

Adjusted basis. The adjusted basis of your property is your original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Your adjusted basis can never be less than zero. See Publication 551, Basis of Assets, for more information on adjusted basis.

You use this adjusted basis for the depletion rate, as indicated in IRS publications, you do not subtract anything from this or add anything to this, you just use this as indicated in Pub 535. Yes board feet is a measure of timber, among many, and may be used in determining the total timber available to harvest as well as the quantities harvested in the current year, but this does not stop you from using the adjusted basis as spelled in the publications you cited.

[xgflek]

As an aside Form T and the instructions for Form T from IRS clearly describing separating your land from your Timber and setting up separate "accounts" for these holdings. So yes IRS is aware that you separate standing timber from land.

From Pub 535
"Timber

You can figure timber depletion only by the cost method. Percentage depletion does not apply to timber. Base your depletion on your cost or other basis in the timber. Your cost does not include the cost of land or any amounts recoverable through depreciation.

Depletion takes place when you cut standing timber. You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation. "

As this indicates cost does not include land, hence land is separate from timber.

[jerome]

As this indicates cost does not include land, hence land is separate from timber.

That is why you have to subtract out the residual value of land before you can arrive at the cost of the timber.

Page 38 of Pub 535 says you have to subtract the residual value of the land from the total cost of the property to arrive at the cost basis for depletion purposes.

It is possible that you have no cost in the timber. This is a case where the taxpayer inherited the property. There was no separate cost for the timber on the property. The land and timber are combined into one amount. So if the value of the land at the end of operations exceeds your total cost in the property, there is no cost that can be allocated to the timber for depletion purposes. And the Pub clearly states you use the value of the land at the end of operations to determine the amount to subtract out.

[xgflek]

At the time of the inheritance there is a FMV of the standing timber on the lot and a separate FMV for the value of the land under the standing timber. These FMV's are the stepped up basis which are inherited, unless the timber is worthless at the time of inheritance you would have a basis in the standing timber and a basis in the land underneath it. This is what is meant by the land being separate from the timber, a consulting forester can help you determine what the appropriate allocations were at the time of the inheritance, as the lot should have been cruised at the time of the inheritance to determine the appropriate FMV's between land and timber for estate purposes. If you argue that there was no separate value at the time of inheritance then you may be saying the timber is worthless, but the current value of the land has no bearing, you would simply have a case where the timber adjusted basis is 0 divided by the total volume of timber gives you a depletion unit of 0 and multiplying by the volume harvested would give you a depletion of 0, such that the $109?? of stumpage income would all be long term capital gains. The land would still have no bearing on the depletion amount taken, you are instead stating that the timber was worthless at the time of inheritance.

Below is link to a good summary of timber tax issues and depletion calculation and again I would encourage anyone to examine Form T.

http://pubs.cas.psu.edu/FreePubs/pdfs/uh131.pdf

and here is another good reference

http://ohioline.osu.edu/for-fact/0030.html

[jerome]

So when the IRS Pub says to subtract out the residual value of land at the end of operations, we just ignor that part???

[xgflek]

IRS says to use the adjusted basis for timber depletion, look right above the residual value line where it says to subtract those from the adjusted basis and look right below the residual value line where it gives the definition of adjusted basis and not that the adjusted basis used for the depletion unit does not require anything of the residual value of the land. That is a subtraction from the adjusted basis and the IRS says to use the adjusted basis in the determination of the depletion unit. There is no residual value of land in timber, timber is timber and land is land. Residual value is only dealt with for mineral property you are extracting from the land not timber you are extracting from above the land.

For further clarification, here is the info on depletion straight from IRS Pub 225 which indicates at the bottom that timber is your economic interest in standing timber. It is only your economic interest in the standing timber and is completely separate from the land underneath it. This is followed by the information on Timber depletion from Pub 535 which further indicates that the cost of land, emphasis on cost. This also references the definition of adjusted basis referenced under mineral property, which I have also included and also does not reference any further allowances for land values and is strictly the cost, (FMV date of death, donor basis for a gift, etc) plus certain improvements, etc. which would be certain reforestation expenses, etc. The information in Pub 535 has a good example of timber depletion and you will note that there are no considerations of land values, but it is strictly limited to the timber property which is being depleted, not the land.



Depletion

Depletion is the using up of natural resources by mining, quarrying, drilling, or felling. The depletion deduction allows an owner or operator to account for the reduction of a product's reserves.
Who Can Claim Depletion?

If you have an economic interest in mineral property or standing timber (defined below), you can take a deduction for depletion. More than one person can have an economic interest in the same mineral deposit or timber.

You have an economic interest if both the following apply.

*

You have acquired by investment any interest in mineral deposits or standing timber.
*

You have a legal right to income from the extraction of the mineral or the cutting of the timber, to which you must look for a return of your capital investment.

A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. A production payment carved out of, or retained on the sale of, mineral property is not an economic interest.

Mineral property is each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See Internal Revenue Code section 614 and the related regulations for rules on how to treat separate mineral interests.

Timber property is your economic interest in standing timber in each tract or block representing a separate timber account.

Timber

You can figure timber depletion only by the cost method. Percentage depletion does not apply to timber. Base your depletion on your cost or other basis in the timber. Your cost does not include the cost of land or any amounts recoverable through depreciation.

Depletion takes place when you cut standing timber. You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation.
Figuring cost depletion. To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit.

Timber units. When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. You measure the timber using board feet, log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate.

The term “timber property” means your economic interest in standing timber in each tract or block representing a separate timber account.

Depletion unit. You figure your depletion unit each year by taking the following steps.

1.

Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property.
2.

Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital.
3.

Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account.
4.

Divide the result of (2) by the result of (3). This is your depletion unit.

Example.

You bought a timber tract for $160,000 and the land was worth as much as the timber. Your basis for the timber is $80,000. Based on an estimated one million board feet (1,000 MBF) of standing timber, you figure your depletion unit to be $80 per MBF ($80,000 ÷ 1,000). If you cut 500 MBF of timber, your depletion allowance would be $40,000 (500 MBF × $80).
When to claim depletion. Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Include allowable depletion for timber products not sold during the tax year the timber is cut as a cost item in the closing inventory of timber products for the year. The inventory is your basis for determining gain or loss in the tax year you sell the timber products.

Example.

Assume the same facts as in the previous example except that you sold only half of the timber products in the cutting year. You would deduct $20,000 of the $40,000 depletion that year. You would add the remaining $20,000 depletion to your closing inventory of timber products.
Electing to treat the cutting of timber as a sale or exchange. You can elect, under certain circumstances, to treat the cutting of timber held for more than 1 year as a sale or exchange. You must make the election on your income tax return for the tax year to which it applies. If you make this election, subtract the adjusted basis for depletion from the fair market value of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. You generally report the gain as long-term capital gain. The fair market value then becomes your basis for figuring your ordinary gain or loss on the sale or other disposition of the products cut from the timber. For more information, see Timber in chapter 2 of Publication 544, Sales and Other Dispositions of Assets.

You may revoke an election to treat the cutting of timber as a sale or exchange without IRS's consent. The prior election (and revocation) is disregarded for purposes of making a subsequent election. See Form T (Timber), Forest Activities Schedule, for more information.

Form T. Complete and attach Form T (Timber) to your income tax return if you claim a deduction for timber depletion, choose to treat the cutting of timber as a sale or exchange, or make an outright sale of timber.

Adjusted basis. The adjusted basis of your property is your original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Your adjusted basis can never be less than zero. See Publication 551, Basis of Assets, for more information on adjusted basis.

[Bird Legs]

Taxi Cab

Client purchased a 2001 vehicle in October, 2005, in order to provide taxi service through
a taxi company. This was done to avoid having to buy or lease it from the company.
Client does pay commissions to cab co. Plus all car expenses.
Question What is the depreciable life of this cab? I set it up for 5 yrs., however,
client says it should be 3 yrs. because of its age. He said this is what the cab company
told him.
Which is correct?
Thanks for all of your input.

[jerome]

IRS says to use the adjusted basis for timber depletion, look right above the residual value line where it says to subtract those from the adjusted basis and look right below the residual value line where it gives the definition of adjusted basis and not that the adjusted basis used for the depletion unit does not require anything of the residual value of the land.

Apparently I don’t understand English the way you do. When I look right above the residual value line in Pub 535, I see the following:

Basis for depletion.

To figure the property’s
Basis for depletion, subtract all the following
from the property’s adjusted basis.
1. Amounts recoverable through:
a. Depreciation deductions,
b. Deferred expenses (including deferred
exploration and development costs),
and
c. Deductions other than depletion.
2. The residual value of land and improve-
Ments at the end of operations.
3. The cost or value of land acquired for pur-
poses other than mineral production.

To me, when it says “To figure the property’s Basis for depletion, subtract all the following from the property’s adjusted basis,” I assume it means to subtract all three of the following to figure the property’s basis for depletion, including the line that says to subtract the residual value of land to figure the property’s basis for depletion.

I guess I will have to go back and take some more English courses, or something.

[xgflek]

Apparently I don’t understand English the way you do. When I look right above the residual value line in Pub 535, I see the following:

Basis for depletion.

To figure the property’s
Basis for depletion, subtract all the following
from the property’s adjusted basis.
.

Yes that is what it says to subtract those from the adjusted basis, now go back and look at timber depletion unit where it says to use the adjusted basis to calculate the depletion unit. It does not say to use the cost depletion basis or the adjusted basis after subtracting stuff, it says to use the adjusted basis as defined right below the area you quoted. Look at Form T, look at the timber depletion examples in Pub 225, look at the timber tax information I linked to earlier and you will never see any mention or residual land value as there is no land in timber.