Page 30 - Tree Line - North Carolina Forestry Association - Third Quarter 2022

PART 2 of a 3 Part Series
Keep More of Your Timber Sale Income by Qualifying for Capital Gain Taxation
interest, the profit from the sale is a long-term capital gain if it meets the requirements of § 631(b).
To qualify for § 631(b) treatment, the forest landowner must sell the trees on the stump. If the forest landowner cuts his own trees or hires someone to cut the trees for him, the sale must qualify under § 631(a) instead.
Selling timber outright is also known as a “lump-sum sale.” Any time a forest landowner enters a contract for a set dollar amount or an individual pays a set annual fee for the right to cut timber, it is a lump- sum sale.
In contrast, a retained economic interest occurs when the forest landowner receives payment based on the volume of timber harvested and title to the timber does not pass until it is cut by the buyer. A retained economic interest agreement is also known as a “pay-as-cut contract.”
Regardless of whether the timber
is disposed in a lump-sum or pay-as-
cut agreement, the sale will qualify for
§ 631(b) treatment as long as standing timber is sold and the forest landowner owned the timber (or had the right to cut the timber) for more than one year.
In contrast to § 631(a), no election
is necessary for § 631(b) treatment. The forest landowner simply reports the capital gain properly on their tax return.
Conclusion
Qualifying for capital gain taxation is often the best way for forest landowners to save taxes. However, applying IRC § 631 to a forest landowner’s individual situation
can be complex; therefore, consulting
a knowledgeable forest Certified Public Accountant (CPA) or attorney is strongly recommended when a forest landowner is contemplating a timber sale.
ABOUT THE AUTHOR
Andrew Bosserman is a tax attorney, Certified Public Accountant, 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 family.
He enjoys hiking in the North Carolina mountains, spending time with family and friends, and volunteering at his local church.
BY ANDREW BOSSERMAN
As discussed in my prior article, “The Most Important Tax Determination for Forest Landowners” (see Vol. 4 Issue 2 of TreeLine), forest landowners should classify timber activity as a business if possible, so that they can deduct all allowable expenses and losses.
The downside of business income
is that it is ordinary income, which is generally subject to ordinary income tax rates (ranging from 10% to 37%) and self- employment tax (an additional 15.3% tax on net earnings from self-employment).
A forest landowner would prefer to have his income classified as long-term capital gain income, rather than ordinary income. Capital gain income is any profit from the sale of a “capital asset.” The most common capital assets are stocks, bonds, and real estate held for investment. The gain on the sale of a capital asset held more than one year is a “long-term capital gain” and is taxed at lower rates (ranging from 0% to 20%) than ordinary income. Capital gain income is also not subject to self- employment tax.
Fortunately, Congress passed Internal Revenue Code (IRC) § 631, which classifies business timber sales as long-term capital gains under certain conditions. This means forest landowners classified as a
business may pay lower tax rates and no self-employment tax on their timber sales.
IRC § 631
IRC § 631 has two different ways for timber sold in a business to qualify for capital gain treatment: 1) IRC § 631(a) covers timber that a forest landowner cuts himself or pays someone to cut, and 2) IRC § 631(b) covers standing timber sold outright or with a retained economic interest.
IRC § 631(a)
A forest landowner who is in the business of selling timber and cuts their own timber or pays someone to cut it on their behalf may qualify for long-term capital gain treatment if they meet the requirements of § 631(a).
First, the forest landowner must have owned the trees or had the right to cut the trees for more than one year.
Second, the forest landowner must split the sales proceeds into two amounts: (1) the resulting gain from holding the standing timber until cutting, and (2) the added value from converting the standing timber into logs or wood products.
The forest landowner calculates the § 631(a) gain (a long-term capital gain) by subtracting the adjusted basis for depletion of the timber from its fair market value
as of January 1 of the tax year the forest landowner cut the timber.
The forest landowner calculates the added value (ordinary income) from converting the standing timber by subtracting the fair market value of the timber processed (and any processing costs) from the sale proceeds of the wood products.
Finally, the forest landowner must
elect § 631(a) treatment on the tax return
by checking the appropriate box on Form
T and separately reporting the income as long-term capital gain and ordinary income.
IRC § 631(b)
If a forest landowner who is in the business of selling timber sells timber outright or with a retained economic
28 ncforestry.org / THIRD QUARTER 2022