Page 30 - Tree Line - North Carolina Forestry Association - Second Quarter 2023

PART 3 of a 3 Part Series
Maximize Timber Basis
Deductions to Minimize Taxes
By Andrew Bosserman
My previous two articles
in this three-part timber tax series discussed forest activity classification
(TreeLine Second Quarter 2022) and utilizing capital gain taxation to save taxes on timber sales (TreeLine Third Quarter 2022). This third and final article will discuss how to maximize timber basis deductions to minimize taxes.
Why Timber Basis Is Important
An accurate and maximum allowable timber cost basis is extremely important for a few reasons.
First, forest landowners must know the basis of their timber to determine profit or loss when they sell timber. Not only is an accurate profit calculation required for tax purposes, it also helps with planning for future plantings and harvests.
Second, forest landowners want the maximum allowable timber basis to lower any taxable profit. The IRS will tax landowners on the forest activity’s net profit. A larger timber basis results in a larger tax deduction, which lowers landowners’ taxable net profit.
However, this does not mean an individual should pay as much as possible for timberland to increase cost basis. The economics of the forestland investment must still make sense. Rather, forest landowners should make sure their timber basis is maximized and computed correctly after a purchase of forestland.
Finally, timber basis is used to calculate a tax deduction due to a casualty loss, such as a forest fire that destroys timber. Recent tax law changes have made deducting casualty losses more difficult; however, a casualty loss deduction is still available to forest landowners in some instances.
Calculating Timber Basis
When forest landowners purchase timberland, they pay a single price and receive multiple assets: the land itself, any existing timber, and any land improvements. A forest landowner will
likely view the transaction as a single purchase and will often pay a single price for all the assets. However, for
tax purposes, the transaction is viewed as separate purchases for each asset or type of asset. The forest landowner must allocate the purchase price among the different types of assets purchased.
Example
Tim Burr purchased 50 acres of forestland in 2022 for $100,000.
The fair market value (FMV) of the land was $50,000, the FMV of the existing timber was $40,000, and the FMVs of existing logging roads were $30,000 (FMV total = $120,000).
How should Tim allocate the $100,000 cost between the purchased assets?
• Land cost basis = ($50,000 / $120,000)* $100,000 = $41,667
• Timber cost basis = ($40,000 / $120,000)* $100,000 = $33,333
• Land Improvements (logging roads) cost basis = ($30,000 / $120,000)* $100,000 = $25,000
In the example above, all the timber Tim purchased was grouped together to calculate a timber basis value. In certain situations, forest landowners may benefit from separating timber into separate tracts or calculating basis by species.
Upon purchasing forestland, the forest landowner should have the timber appraised by a forester to calculate a maximum allowable timber cost basis. This will result in a lower tax bill when the timber is sold, as well as a larger tax deduction if the timber is unfortunately destroyed due to a casualty or theft.
An appraisal should also be performed when timberland is inherited. Tax law permits an individual who inherits timberland to “step up” their basis in
the timberland to its fair market value, effectively exempting any appreciation in the hands of the decedent from taxation. Failing to properly calculate timber basis can result in thousands of dollars of unnecessary taxes when the timber is sold.
Qualified Reforestation Expenditures
Generally, the cost of planting tree seedlings and related planting expenses are not deductible until the owner sells
or harvests the timber. However, tax law permits a forest landowner to immediately deduct up to $10,000 each year of “qualified reforestation expenditures.”
Qualified reforestation expenditures include the cost of land preparation, the cost of the seeds or seedlings themselves, and the cost of planting labor. Despite
the term “reforestation expenditures,”
the owner need not incur the expenses
in replacing a harvested timber stand.
A forest landowner can deduct qualified reforestation expenditures for establishing new timber stands.
This special tax treatment for such expenditures is not automatic. A forest landowner must make an election on their tax return to be eligible for the maximum $10,000 deduction.
Any reforestation expenditures exceeding $10,000 may be amortized (deducted) over 84 months.
Conclusion
Maximizing timber cost basis is a critical component of tax savings for forest landowners. However, calculating timber basis for a forest landowner’s individual situation can be complex; therefore, consulting a knowledgeable forest Certified Public Accountant (CPA) or attorney is strongly recommended.
ABOUT THE AUTHOR
Andrew Bosserman is a tax attorney, CPA, and former IRS agent with an in-depth knowledge of the forest and Christmas
tree industries gained through owning and operating his own tree farm. He currently practices tax and corporate law at the Charlotte office of Shumaker, Loop & Kendrick, LLP. Andrew lives in Charlotte, NC with his wife Sallie, where they enjoy hiking in the North Carolina mountains, spending time with family and friends, and volunteering at their local church.
28 ncforestry.org / SECOND QUARTER 2023