Tax Considerations for Forest Landowners

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Tax Considerationsfor Forest Landowners

• Mike Jacobson
• School of Forest Resources
• Penn State
• Nov 11, 2008
• PSU Webinar

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Facts

• Taxes are a major cost of doing business
• Proper tax planning is every bit as important as
  the silvicultural techniques used to grow
  profitable forest crops.
• Congress has provided several favorable
  advantages and elections to STIMULATE INCREASED
  PRODUCTIVITY from the nations private forest
  lands.

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Caveat

• Its complicated stuff
• the hardest thing in the world to understand is
  income tax
• Albert Einstein
• This information and discussion should be treated
  as EDUCATIONAL, not legal advice.
• Every situation is different
• Discuss with professional tax team

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Types of Forest Taxes

• Types of forest taxes
• Income taxes
• 2005 changes
• Timber sales and capital gains (631b)
• Reforestation deductions
• Estate taxes
• 2 m credit 2006-2008
• Property taxes
• Clean Green (in PA)

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Topics

• Establishing basis
• Expenses
• Timber Income
• Other tax considerations
• Estate planning
• Conservation easements

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Establishing a basis

• A capital investment in income-producing property
• The law usually requires that basis be
  capitalized held in a capital account until
  the property is sold
• Tax rule any expenditure of asset with life of
  greater than 1 year must be capitalized
• Basis is the book value of asset
• determined by how much you paid for it
• Recover basis with timber sale
• Use Form T

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Original Basis

• PurchaseTotal cost to acquire the property, NOT
  just its purchase price and NOT its fair market
  value
• Inheritance Propertys fair market value on the
  date the decedent died OR the alternate valuation
  date (earlier of 6 months after death or date any
  estate asset is sold)
• Usually results in a step-up in basis
• GiftLower of donors basis (carry-over basis) or
  propertys fair market value

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Original Basis

• Ideally, determine original basis immediately
  after you acquire timber or forestland
• If you postpone process for several years, you
  may need the help of a forester to determine the
  trees original volume and value
• Allocate original basis proportionately among
  your capital accounts for example, Land
  Account, Timber Account

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Adjusted Basis

• Adjust capital accounts
• Up by the amount of new purchases or investments
• Down as you recover your investment
• Adjusted basis The balance left in a capital
  account after one or more changes have been made
  to the original basis

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Expenses- Advantage of being in the business?

• Profit motive
• The term profit also includes appreciation in
  the value of the assets.
• Expensing
• Expenses, property taxes, interest, etc are fully
  deductible against income from any source.
• Expanded Section 179 deduction
• New law effectively increases the limit to
  250,000 and the phase out threshold to 800,000
  for 2008
• Reverts to 125,000 and 500,000 phase out in
  2009
• Bonus depreciation 50 of adjusted basis

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Passive Loss RulesThe Three Categories

• Timber held for the production of income, such as
  an investment, but which is not part of a trade
  or business.
• Timber held as a part of a trade or business in
  which you do not materially participate (i.e.,
  one in which your activity is passive).
• Timber held as part of a trade or business in
  which you materially participate (i.e., one in
  which your activity is active).
• Tests for material participation
• See www.timbertax.org questionnaire

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Operating expenses and carrying charges

• Engaging in timber-growing for profit, these
  expenses can be deducted in the year they occur.
• Examples Include
• Labor costs, consultant fees, timber stand
  improvement, precommercial thinning
• Carrying costs - property taxes, interest
• Can be capitalized in years your tract produces
  no income, but it usually is more beneficial to
  deduct them

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Timber Income

• Both the amount and type of income received are
  important
• Amount Price Expenses Timber Basis
• Type Ordinary income or capital gain
• Your primary purpose for owning timber (passive
  loss rules apply)
• How long you have held it (how acquired)
• How you dispose of it (3 methods)

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Type of Income is Important

• Long-term capital gains - 15 and 5 for the
  bottom 2 brackets (0 for 2008-2010)
• Highest ordinary income rates 35
• Ordinary income you earn from timber is subject
  to self-employment taxes, at rates up to 15.3
• If you have large capital losses, apply them
  against any amount of capital gains
• If you are retired, capital gains do not count
  toward the amount of income you can earn before
  your Social Security benefits are cut

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Qualifying for capital gains

• How disposed of
• By a lump-sum sale or exchange
• 1099 will be required
• A Section 631(b) disposal, through a pay-as-cut
  contract or outright sale
• A Section 631(a) transaction, by cutting the
  timber yourself, converting it to products for
  sale,

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Reforestation Amortizationand Deductions

• The American Jobs Creation Act of 2004 changed
  the nature of the incentives
• Two tax incentives reduce or eliminate the need
  to hold reforestation expenses in a capital
  account until you sell timber or timber products
• You can deduct reforestation expenses up to
  10,000 per year of qualifying reforestation
• And for those expenses over 10,000 you can
  amortize write off over an 8 year period

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Cost-share Payments

• Generally, you are required to report government
  cost-share payments as part of your gross income
  (1099G).
• However, under Section 126 of the IRS Code, all,
  or part of, certain government cost-share
  programs MAY be excluded from gross income.
• Substantial increase in annual income
• Nevertheless, even if you choose to exclude an
  approved government cost-share payment, YOU MUST
  REPORT IT!

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Involuntary Conversion

• If you lose timber in an involuntary conversion,
  you may be entitled to an income tax deduction,
  if not reimbursed by income or otherwise
• Casualty loss,
• Noncasualty loss
• Theft loss
• Condemnation

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Court cases last 10 years

• Have management plan
• Keep good records
• Get expert forestry advice
• Show how improvements/expenses contribute to
  profit motive
• Be careful about deducting travel/meal expenses
• Absentee owners need to separate work been done
  for income or pleasure
• Differentiate between personal and income
  activities, especially if live on the property

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Record Keeping

• Form T
• Records consist of many things
• Timber management plan
• Receipts for business transactions
• Odometer readings, diaries, time recording for
  the time spent managing the trade or business
• Agendas to training meetings
• Membership records in business related
  associations
• Contracts
• Invoices

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Estate planning- forestland issues

• Explosive land values
• High estate tax rates (unexpected values)
• Families dont realize need (unexpected heirs)
• Reasonable planning horizon exceeds lifetime
• land rich, cash poor
• Uncertainty law will change

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Three common phrases

• we dont need a will
• we have a will were all set
• we want to treat our children fairly, so we will
  divide everything equally among them
• Communication is the key
• Dying is as much as part of living. To die well
  is to do so in consideration of the people you
  leave behind.
• Its not just about the taxes

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Federal Estate Tax Applicable Exclusion 26 U.S.C.
2010

• Deaths in 2006-2008 Applicable Exclusion Amount
  2,000,000
• Year of Death Applicable
  Exclusion
• 2009 3,500,000
• 2010 tax repealed
• (but carry over basis)
• 2011 1,000,000

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PA Inheritance Tax Rates

• 0Spouses Charities, gifts to government
• 4.5 Lineal Descendants
• 12 Siblings
• 15 All others
• Transfers Not Subject to Tax
• Transfers to Spouses
• Life insurance proceeds regardless of where they
  are paid
• Family exemption of 3,500 to designated
  beneficiaries who satisfy the conditions

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Tools and strategies

• Utilize unified credit
• Marital deduction
• Trusts
• Life insurance
• Installment payments
• Special use valuation
• Business transfers
• Lifetime gifts (24,000/year)
• Gift tax does not end in 2010
• Carry-over basis
• Conservation easements

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Tax Planning Opportunities with Conservation
Easements

• Real estate taxes on easement property should be
  reduced.
• Income tax benefits (IRC 170(h)) to individual
  landowners who donate or bargain sale
• A Qualified Real Property Interest
• to a Qualified Organization
• Exclusively for conservation purposes

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Tax benefits from donation of easement

• Charitable deduction in 50 of AGI (was 30)
• Excess deduction amounts can be carried forward
  for 15 additional tax years (was 5 years).
• Additional exclusion of up to 500,00 (IRC 2031c.

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Summary

• Part of forest management
• Timber is long term
• Be in the timber growing business
• Capital gains
• Expensing
• Reforestation incentives
• Establish profit motive
• Recordkeeping
• Plan your estate now!

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Further information

• Timber tax website
• http//www.timbertax.org/
• Penn State Forestry Extension Website
• http//rnrext.psu.edu
• Mike Jacobson mgj2_at_psu.edu
• 814-865-3994