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Tax Savings on Timber Sales
Understanding tax laws and tax The long time involved in timber Capital Expenditures
incentives designed to encourage production increases the importance Capital expenditures are associated
improvement and expansion of of establishing a systematic recording with acquiring property (or property
woodlands will benefit both you and system, so you can reconstruct all rights with a useful life of more than
the general public. activities related to timber production. one year). Capital expenditures also
Your records should indicate your include costs for permanent
Growing trees as a crop can be plans for the timber property and also improvements that increase the value
profitable if you keep expenses in line document your production goals. of property already owned. Capital
with expected returns. Before expenditures must be capitalized; that
investing money, plan a program of Before investing in woodlands, plan is, the amount may not be deducted in
management with your goals in mind. what records you’ll need and how you the year of purchase. Therefore, it is
Are you growing trees for pride of will maintain them. necessary to establish accounts to
ownership, to build estate value, as an record these costs and the amounts
inflation hedge, for retirement income, Journal Account. For small depreciated or depleted each year.
for an educational fund for your woodlands requiring minimum Three subaccounts are usually set up
children, or for periodic income? management activity, a journal under capital expenditures: land,
account may be adequate for timber, and equipment.
Consider your particular resources. recording necessary information.
Important factors include the A journal is simply a business diary You must establish a cost basis for
productivity of the soil, the type and describing each activity, date, and the your land, timber, and equipment. If
number of trees per acre, available dollar amount involved. you acquire woodland by exchanging
financial resources, and investment other investment property, your basis
alternatives. Ledger Account. As the number of in the timber land is the basis of the
tracts, cultural operations, and real property exchanged plus or minus
A clearer understanding of tax laws harvesting activities increases, a any additional money exchanged.
should assist you in realizing greater simple journal becomes inadequate
after-tax income. This can be for proper tax management. Larger The basis of property acquired by
achieved by choosing the method of operations need more extensive inheritance is generally the appraised
selling timber that reduces tax liability, records. A good record system should fair market value for the decedent’s
taking the deductions permitted by include information on the following estate.
law, and establishing complete items:
records. I. Capital Expenditures The basis of property received by gift
A. Land account is generally the adjusted basis of the
Records 1. Nondepreciable property in the hands of the donor.
Complete, documented records are as 2. Depreciable
essential on woodlands as on all other B. Timber account Land Account. Assets carried in the
farm property. Records are needed to 1. Merchantable timber land account include land and
determine the cost of production and 2. Young growth improvements to the land. Land (and
to establish a basis for casualty losses 3. Reforestation any permanent improvement to land,
and taxes. Also, you need good C. Equipment account such as a permanent road or
records in instances of involuntary II. Operating expenses firebreak) is treated as a
conversions and to establish the value Ill. Carrying charges nondepreciable asset. The cost of
for credit, a sale, or for estate taxes. IV. Sales expenses nondepreciable assets can only be
recovered when title to the land
PM 1162 Revised October 1988
Electronic version June 2000
changes hands. Land cannot be you sell all the timber, you can take all you are married and filing separately),
depreciated or depleted. the basis of such timber as depletion. but it does not apply to capitalized
When only a portion is sold (as with a carrying charges.
Some improvements that increase the thinning), the depletion must be
value of land do have a fixed life, and divided between the remaining timber Another provision of the law allows for
their cost can be recovered through and the amount sold. Total depletion an investment tax credit for
depreciation. Examples of depreciable can never exceed the cost. reforestation expenses. To qualify
assets are culverts, bridges, fences, under PL 96-451, the reforested land
temporary roads, and fire lanes. The timber account is usually divided must be greater than one acre, must
Normally, a separate subaccount is into three subaccounts: merchantable be capable of commercial timber
established for depreciable assets. timber, young growth, and production, and must be held for that
reforestation. purpose or for ultimate sale of timber.
Timber Account. You must establish The law has been interpreted to
a cost basis for the timber to provide a Establish a young growth subaccount exclude Christmas tree production.
depletion allowance when you harvest for valuable, but unmerchantable, For more information on reforestation
the timber. A cost basis requires young timber. For example, assume expenses, obtain Iowa State
estimates of the fair market value of that a stand of three-year-old University Forestry Extension Note
the timber as of the date of purchase seedlings has become established on F-336, Tree Planting Tax Incentives.
or acquisition. Factors considered in 30 acres of land and a value of $50
arriving at fair market value include per acre has been determined. A total Equipment Account. The equipment
the species, age, size, and quality of of $1,500 would be entered in the account includes the usual equipment
the timber; the quantity of timber per young growth subaccount. Transfer associated with a woodland operation:
acre; accessibility; and freight rates by amounts from the young growth chain saws, tractors, logging trucks,
common carriers to markets. The account to the merchantable timber and skidders. These items are capital
appropriate time to establish the cost account as the trees become assets and should be depreciated.
basis is when you acquire the merchantable.
property. But you can reconstruct it Deductible operating costs include
later when necessary. A reforestation subaccount should normal repair and maintenance of
show capital expenditures incurred equipment. Major repairs that increase
It is important to maintain an accurate within three years of harvest to the life of the equipment, such as an
timber account. Collecting this regenerate a stand, such as site engine overhaul, are treated as capital
information is important to both preparation, cost of seed, seedlings, investments that must be depreciated.
woodland and financial management. planting, and competition control.
The adjusted cost basis is the starting If you farm, the woodland operation is
point for nearly all tax calculations Before 1980, reforestation expenses probably incidental to the farm
relating to timber. could only be recovered by selling the business, and you will maintain a
timber. This requirement tied up single farm equipment account. But if
For quantity of timber, enter the total investment capital for many years and the woodland operation is a separate
volume the tract would have produced was thought to deter tree planting. business, you must set up separate
if all the merchantable timber had Public Law 96-451, enacted in depreciation accounts.
been cut on the date you acquired the October 1980, states that
property. Express this quantity in expenditures incurred after 1979 must Operating Expenses
board feet, cords, or some other still be capitalized. But they may be To determine whether costs are
standard unit of measure. amortized (depreciated) over an deductible, ask whether the business
84-month period. This allows complete or investment property generates a
Depletion is your original cost basis of recovery of capital in seven years profit. Costs are deductible if a
the timber with adjustments for any rather than 20 or more under the old business activity generates a profit in
capital additions or deductions. law. The amortization provision three or more of five consecutive
Depletion is used to reduce your applies to all qualifying reforestation years. This requirement prevents
taxable gain when the timber is sold. If costs up to $10,000 a year ($5,000 if someone who owns a forested tract
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and uses it only for recreational If the forestry enterprise is incidental arrive at net sales proceeds. The
purposes from deducting operating to a nonfarm business or profession, resulting amount is reported on
costs as a business expense. or if it constitutes a business in itself, Schedule D or Form 4797, depending
costs are reported on Schedule C. upon the purpose for which timber is
You might wonder, though, how held and the manner of disposition.
landowners, who might sell timber Deductions for expenses are subject
only once or twice in their lifetimes, to the passive loss rules. Reasons for Holding
can fulfill the profitability requirement. Forest Property
Inability to fulfill the requirement does Carrying Charges The tax treatment associated with
not automatically deny deductibility. Carrying charges is a somewhat woodland property depends on how
Moreover, the IRS interpretation of vague category that covers costs the property is used. Woodland
profit also includes appreciation in the necessary to maintain possession of property is held for three basic
value of assets. Therefore, total profit woodland. Property taxes, interest on purposes: personal use, investment,
is the sum of income plus appreciation a loan to purchase or improve the or business.
minus operating costs. Because land property, administrative costs,
and timber values have risen insurance premiums and the cost of Personal Use
consistently in the past, landowners maintaining fire lanes, are considered Property not used to produce income
should have little difficulty justifying carrying charges. So, too, are special is held for personal use. The house
the profitability of their investments. expenditures to prevent outbreaks of and land that serve as your residence
disease or insects. are examples. Even though you might
Landowners are frequently advised expect to sell them some day for more
that the costs of timber stand Carrying charges may either be than you paid for them, your primary
improvement (TSI), thinnings not for expensed or capitalized. For any year reason for holding them is to give you
the purpose of sale, and timber carrying charges are to be capitalized, a place to live. Likewise, you may own
cruises (estimates) are not deductible. a statement to that effect should forest property mainly for your
But these costs are deductible if they accompany the tax return. Election to personal use as a site for a second
are part of the normal management capitalize is only valid for the year it is home or for recreation.
program and do not relate directly to made. The following year carrying
reforestation, sale, or puchase of charges may again be expensed if Investment
timber or land. Similarly, pruning and desired. This opportunity to alternate Property used to produce income but
shearing expenses for cultivated between expensing or capitalizing not as an integral part of a trade or
Christmas trees are deductible, but carrying costs at the taxpayer’s choice business is investment property. For
the costs of shaping naturally grown is not extended to other types of example, the land holdings of many
conifers into Christmas trees are not costs. farmers include woodlots. In most
deductible. The latter practice adapts cases, the activities associated with
property to a new or different use, for It is usually best to expense qualified the woodlot are incidental to the
which costs must be capitalized. items rather than capitalize them so primary crop and/or livestock
you can save current taxes. However, production. As such, the timber would
Individual landowners, holding timber these costs are subject to the passive be considered investment property.
as an investment, report operating loss rules. However, if the timber-related
expenses to the IRS as itemized activities are extensive in relation to
deductions on Schedule A. Farmers Sales Expense the overall activities carried out on the
list these costs individually as “other If revenue from the sale of timber is farm, the timber may be a separate
expenses” on Schedule F. Timber reported as ordinary income from a business.
expenses and income are reported as business, sales expenses are simply
farm transactions if they are incidental treated as deductions and reported to Business
to the farming enterprise, even if a the IRS on Schedule C or F. If the Property is held for use in a trade or
portion of the farm is entered in a tree timber qualifies as a capital asset––in business if it is an integral part of an
farm program. most cases it will––sale expenses are activity entered into and carried on in
subtracted from the gross sale price to good faith for the purpose of making a
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profit. The characteristic elements timber income qualifies for capital Methods of Selling Timber
are regularity of activities and gains. There are three sales methods timber
transactions, and the production of 1. The purpose for which the timber owners can use to qualify for capital
income. was held. gains treatment.
2. The length of time the timber was 1. Sale of standing timber for a lump
Determining your primary reason for held before disposal. sum (lump-sum sale).
holding a particular forest property is 3. The form of the timber disposal. 2. Disposal of timber with an
based on all the facts related to your 4. The nature of the timber product. economic interest retained
intended and actual use of the 5. The number, continuity, frequency, (sell-as-cut). IRS Code Sec. 631 (b).
property. No single factor controls your and amount of sales (not just isolated 3. Cutting standing timber with
decisions. Your intent when you first transactions), or any other facts that election to treat as sale (used in trade
acquire the property is not conclusive indicate your occupation as a seller. or business). IRS Code Sec. 631(a).
if later your activities change.
Generally, standing timber owned by a Sale of Standing Timber
How the IRS Defines Timber farmer is a capital asset because for a Lump Sum
Timber is defined by the Internal timber is not held for sale in the The simplest method of selling timber
Revenue Code as the wood in ordinary course of farming operations. is a lump-sum sale. It is probably the
standing trees that is to be recovered If timber qualifies as a capital asset, a most common method used by
when the trees are cut and processed. sale of standing timber would farmers and small landowners for
It includes the standing trees usable ordinarily result in either long-term or selling timber. A lump-sum sale may
for lumber, pulpwood, veneer, poles, short-term capital gain. cover a given acreage, tracts, certain
crossties, piling, and other wood species, or diameter classes of trees.
products. As defined by the Internal To determine the cost or other basis The timber must be sold for a fixed
Revenue Code, timber has the same for each unit of timber, divide the amount agreed upon in advance.
meaning as stumpage, a word used value in the merchantable timber
by professional foresters. account by the volume in the Lump-sum sales are for landowners
merchantable timber account. This is who hold timber as an investment or
Once trees are cut, they cease to be done in line 34 of Schedule F of Form for personal use. Standing timber is
timber for income tax purposes. T. Take this value times the number of considered to be a capital asset if the
units sold to determine the cost or property is not held primarily for sale
The simple act of cutting standing other basis for the timber sale. This is to customers, or if the property is not
trees converts timber from real usually referred to as depletion used in the owner’s trade or business.
property to wood products and allowance. If a farmer makes infrequent sales of
personal property. standing timber, all lump-sum sales
Depletion, in its simplest form, is your should qualify for capital gains
Consequently, any gain from the sale original purchase price of the timber treatment.
of standing timber should qualify as with adjustments for any later capital
capital gain, while any gain from the additions or deductions. Where all the Example of a Lump-Sum Sale: The
sale of wood products is ordinary timber is sold, all the cost of such simplest example would be where an
income. timber can be taken as a depletion individual made a lump-sum sale of all
allowance. Where only a portion is merchantable timber on a tract for
Ordinary Income versus Capital sold, depletion must be prorated $37,500. Sales costs were $2,250.
Gains Income between the volume sold and the The timber was located on a tract of
Ordinary income (gains) is subject to volume remaining in the stand. The land puchased 20 years ago for
self-employment taxes (social total depletion taken can never $30,000. At the time of purchase,
security). Capital gains are not. exceed your cost or other basis. $20,000 was allocated to the cost of
land and $10,000 to the cost of
Qualifying Timber for Long-Term To support a claim for capital return- merchantable timber.
Capital Gains able through depletion, fill out lines 27
Five factors determine whether or not to 51 of Schedule F of Form T.
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The gain is: Under a pay-as-cut contract, gain disposes of logs and other wood
Sales receipts $37,500 realized is reported as capital gains products. The owner must cut the
Less cost of sale –2,250 income, even if the timber was held standing timber or have it cut by
cost of timber –10,000 for sale or the seller was a dealer or someone else under contract. In all
–––––––– speculator in timber. cases, the owner must retain title to
Gain $25,250 the standing timber and wood
Advantages of 631(b) transactions: products.
The gain of $25,250 is long-term • Timber is included within a special
capital gain income. You would report tax category of business property Definition of ownership: To claim
sales receipts, costs, and gain on (Sec. 1231) subject to capital gains longterm capital gains, an owner is
Schedule D, Form 1040 for federal treatment. anyone who has owned or has held a
income taxes. • The question of whether timber is contract right to cut timber for more
held for sale to customers does not than one year. A contract right means
Had depletion and capital gains not arise, as it does in lump-sum sales. you must have an unrestricted right to
been claimed, the taxable gain would • Ownership is broadly defined. It sell timber cut under a contract or to
have been the sales receipts minus includes any person including a use the timber in your trade or
the cost of the sale ($37,500 – $2,250 subleaser and the owner of a business.
= $35,250). The tax liability on right-to-cut contract who owns an
$35,250 is significantly larger than the interest in timber. An interest in timber Gain reported in two parts: These
tax liability on $25,250. is the right to cut for sale on your are: (1) The difference between the
account or for use in trade or basis and fair market value, as of the
Disposal of Standing Timber with business. first day of the taxable year in which it
Economic Interest Retained, is cut, is capital gain or loss; and
IRS Code Sec. 631(b) Example of a 631 (b) Sale: In 1965, (2) proceeds of sale minus fair market
If you dispose of timber and retain an J. J. Jones purchased a farm for value on January 1 are ordinary
economic interest, you must receive $30,000. Jones allocated $7,500 of income.
payment at a specified rate for each the cost to timber and $22,500 to the
unit of timber cut. This type of disposal land and improvements. Now there is Election under 631(a) is binding with
is commonly referred to as a 250,000 board feet of timber, of which respect to all eligible timber that you
pay-as-cut contract. Jones sells part of it for $120 per cut in the year of election and
1,000 board feet. The sale produces subsequent years. You must obtain
Under a pay-as-cut contract, the price 100,000 board feet. The basis of permission from the IRS
per unit (dollars per 1,000 board feet, timber is $30 per 1,000 board feet Commissioner to change. Your
for example) is determined in ($7,500 ÷ 250). election to use 631(a) is indicated
advance. But the amount of timber to merely by computing your taxes
be harvested is not. Receipts are The gain is computed as follows: according to the provisions of Section
based on the volume actually Gross sales 100 MBF @ $120 $12,000 631(a) and then completing
harvested. The seller retains an Depletion allowance Schedules C and F of Form T.
economic interest (legal title) to the 100 MBF x $30 –3,000
standing timber until it is cut. The Reporting requirements under
Capital gain $9,000
purchaser must have the right to cut Section 631(a) are generally the
and use the timber to the exclusion of Mr. Jones should fill out Schedules C same as for Section 1231 gains and
all others. and F of Form T and enter the gross losses. Report the gain or loss on
sales price, depletion allowance standing timber on Form 4797 with
The disposal date is the date the (basis), and gain in Part 1, Form 4797. other Section 1231 transactions for
timber is cut. Cut is defined as the the year. Report profit or loss on the
time when volume can be measured. Cutting of Timber and Treatment sale of the cut products on a business
The seller may elect to treat the date as a Sale, IRS Code Sec. 631(a) Schedule C, Form 1040, or on
of payment as the date of disposal, if With this disposal method, the owner Schedule F, Form 1040, if you are a
payment is made before cutting. cuts standing timber and then farmer.
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Report the $1,440.20 gain with any of the trees cut during the year. This
Example of a 631(a) sale: S. Smith, a other Section 1231 gains or losses on value must be determined as of the
calendar-year taxpayer, cut 60,000 Form 4797 Part 1. Report the income first day of the taxable year in which
board feet of timber during 2000 from of $3,300 and expenses of $2,880 on the timber is cut. For growers
a tract purchased in 1979. Also, in Schedule C (Form 1040), or Schedule reporting on a calendar year basis,
2000 at the roadside next to the tract, F (Form 1040) if you report it as a this date would be January 1. For
he sold the sawlogs produced. He farm business. These entries would be calendar-year tax payers, fair market
received $3,300 for the logs. The fair supported by Schedules C and F of value is generally determined by the
market value of the standing timber he Form T. condition of the trees at the time they
cut was $30 per 1,000 board feet are cut and prevailing market prices
(MBF), or $1,800 as of January 1, Capital Gains on during the previous cutting season.
2000. His basis in the timber cut was Christmas Tree Sales However, to determine the value as of
$355.80. His logging and skidding In general, most Christmas tree the first day of the taxable year, you
costs totaled $1,080. Because he had producers are subject to the same must discount for the time element,
owned the timber for more than one provision as timber owners. The and the risks borne during the growing
year, he elected to report the cutting regulations provide that for purposes season.
under Section 631(a). The of Section 631 of the Code, the term
determination of the gain or loss on timber includes evergreen trees that If you sell Christmas trees and are a
the cutting of the timber separately are more than six years old at the time calendar-year taxpayer, you can
from the gain or loss from the sale of they are severed from their roots and simplify your 631(a) calculation by
the sawlogs is as follows: sold for ornamental purposes, such as changing to a fiscal tax year by a
Christmas decorations. request to the IRS.
Gain from Cutting
Fair market value, as of Generally, Christmas tree growing Additional Information
January 1, 2000 of timber constitutes a trade or business. As Income tax treatment of timber
cut during 2000 $1,800.00 such, capital gains treatment depends transactions is a complex subject.
on qualifying for treatment under Landowners are advised to consult
Less: Cost or other basis 355.80 Section 631(a) if you cut the trees their tax preparer or attorney to
yourself, or Section 631(b) if you sell determine specific interpretations of
Section 631(a) gain the trees on the stump. the regulations.
(to be reported as a
Section 1231 gain) 1,444.20 Choose and cut sales may not qualify Note: The information in this publication is
the proceeds for capital gains for general educational purposes only and
Gain from Sale of Sawlogs at treatment. Purchasers who cut their in no way is intended to substitute for legal
Roadside own trees acquire both the right and advice. Such advice, whether general or
applied to specific situations, should be
Proceeds from sale the obligation to purchase the cut tree.
obtained by consulting the Internal
of sawlogs $3,300.00 The grower is selling cut Christmas Revenue Service or your tax counsel.
Less: Fair market value, trees, not standing timber. Election
as of January 1, 2000 $1,800.00 under 631(a) is required to receive File: Forestry 3
Logging costs $1,080.00 capital gains treatment in this Prepared by David W. Countryman,
Cost of logs sold $2,880.00 situation. These requirements include professor, department of forestry, and
Ordinary Income $ 420.00 determination of the fair market value Paul H. Wray, extension forester.
… and justice for all Issued in furtherance of Cooperative Extension work, Acts of May
The U.S. Department of Agriculture (USDA) prohibits discrimination in all its 8 and June 30, 1914 in cooperation with the U.S. Department of
programs and activities on the basis of race, color, national origin, gender, Agriculture. Stanley R. Johnson, director, Cooperative Extension
religion, age, disability, political beliefs, sexual orientation, and marital or Service, Iowa State University of Science and Technology, Ames,
family status. (Not all prohibited bases apply to all programs.) Many mate- Iowa.
rials can be made available in alternative formats for ADA clients. To file a
complaint of discrimination, write USDA, Office of Civil Rights, Room 326-W,
Whitten Building, 14th and Independence Avenue, SW, Washington, DC
20250-9410 or call 202-720-5964.
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