Documentation for an online calculator to aid in federal timber tax-related decisions
Timber Tax Basics
The tax treatment of timber harvest income is an important consideration when determining the financial returns of forestland. Assuming property has been held for at least a year, when there is a timber sale, the proceeds of the sale can be taxable as a long-term capital gain, 5 rather than ordinary income. This often results in a reduced tax rate, among other benefits. In addition to income qualifying as a long-term capital gain, landowners can consider deductions that are available to them based on their ownership type.
There are three main types of forestland ownership, each with different federal income tax implications:
1) Personal use property is held for personal use. Income is not a stated priority for the property though timber harvesting can occur.
2) Investment property is held with income as a stated priority, but the landowner does not regularly and continuously engage in the property’s management.
3) Business property is held by a landowner with income as a stated priority and the landowner materially participates in the business.
Deductions are mainly restricted to investment and business ownerships. Eligibility for specific deductions can vary by ownership and are nuanced. More information on the requirements for each ownership as well as deduction eligibility are available at the National Timber Tax website timbertax.org.
One of the most common, accessible, and advantageous deductions is the depletion deduction.
Forest landowners establishing a timber basis (through a timber and land appraisal) can reduce federal income tax. With a timber and land appraisal, a cost basis for the timber (timber basis) is calculated. The timber reserves are “depleted” as harvesting takes place and the income on that timber attributed to and up to the amount of the timber basis is not taxed.
Establishing a timber basis typically costs money because an appraisal is necessary for the calculation, but it can result in tax savings through the depletion deduction. The decision model, based on the assumptions of the user, serves to answer the question “How much do depletion deduction tax savings exceed timber basis costs?” In other words, how much money will establishing a timber basis save a forest landowner?
In the best circumstances, establishing a timber basis will result in a financial benefit to the landowner, i.e. the tax savings will offset or exceed the costs of establishing the timber tax basis. In many cases, the tax savings will not exceed the appraisal costs. In these cases, establishing a basis can serve to partially offset the cost of an appraisal, and the decision model presents the net cost of the appraisal after tax savings.