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Tax Considerations for Forest Landowners

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Title: Tax Considerations for Forest Landowners


1
Tax Considerationsfor Forest Landowners
  • Mike Jacobson
  • School of Forest Resources
  • Penn State
  • Nov 11, 2008
  • PSU Webinar

2
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.

3
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

4
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)

5
Topics
  • Establishing basis
  • Expenses
  • Timber Income
  • Other tax considerations
  • Estate planning
  • Conservation easements

6
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

7
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

8
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

9
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

10
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

11
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

12
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

13
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)

14
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

15
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,

16
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

17
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!

18
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

19
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

20
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

21
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

22
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

23
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

24
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

25
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

26
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

27
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.

28
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!

29
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
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