By Henry Barclay, III, C.P.A.
Lehmann, Ullman and Barclay LLP
2005 has been a stormy year. First, we had to deal with the effects of Hurricane Ivan from 2004 and then we were hit with Dennis and Katrina in 2005. Casualty losses and how to claim them have been much of the story for this year.
Issues We Will See Again
One of the frustrations for landowners, their foresters and tax preparers is determining the basis which you have in your timber. Timber casualty losses are allowed to the extent that the Fair Market Value of the Timber before the Casualty exceeds the Fair Market Value after the casualty less estimated salvage proceeds. This loss amount is allowed to the extent you have basis in your timber. If there is no basis, there is no casualty.
I have posted two helpful items from IRS on our web site (www.lub.com) under “Timber Issues” — the new audit guide for timber casualty losses and the field directive relating to evaluation of losses by IRS personnel. They provide a road map and highlight the areas that IRS sees questions.
For all of 2005, reforestation expenditures are deductible in toto: you may elect to deduct currently the first $10,000 of expenditures and you may amortize the expenditures you do not elect to deduct. The amortization is spread equally over an 84 month period with 6 months’ of deductions in the first and last years. The $10,000 limitation is applied
at the entity level. If you have an LLC, partnership or S corporation, it may elect a $10,000 current deduction which will then be allocated to the owners. Each owner may not elect more than $10,000 of current deductions. By the way, husband and wife get one $10,000 deduction between them.
Trusts are not eligible for the write-off of reforestation expenditures, and they must be capitalized with respect to the trust and taken into account by the trust when the timber is sold. This is true even if the trust is a shareholder in a partnership (etc.) and receives a distribution of reforestation deductions or amortizable reforestation expenditures. The trick is to maintain a record for the next 40 years of the trust’s basis in the timber so that it can be deducted at sale.
IRS now allows taxpayers to deduct the costs of post establishment fertilization and treat these costs just like any other Silvicultural expenditure.
For all of calendar year 2005, taxpayers who are in the trade or business (reporting their timber costs on Schedule C or F) may now recognize capital gain income from the sale of timber by lump sum timber deeds. This was a significant change to eliminate a tax trap and provide a better opportunity for taxpayers to market their property. The sale will still be recognized on Schedule 4797 and will carry to Schedule D on the return and qualify for capital gains.
Sale of Salvage Timber
Many timber owners have sold salvage timber during 2005. You may elect to DEFER the gain on the sale of this timber if you intend to invest the sales proceeds into “similar” property. Similar property would be other timber or timberland, land improvements, related equipment and a host of others. What you want to consider is this: tax is paid on the gain from the sale of timber at capital gains rates (15% or 5% Federal only). If you are in a higher tax bracket, this is beneficial to you. If you invest your gain into reforestation, you will not receive an ordinary income deduction as described above. In essence you will trade the payment of a low tax on a gain today for the loss of an ordinary deduction today or in the future. It may be to your advantage to pay the capital gains tax today and take an ordinary deduction. You will have to crunch some numbers on this, but it is important.
Generally, you have the two years after the year of the first salvage receipts to reinvest deferred gains. However, Katrina victims have an additional three years for reinvestment.
The Katrina Relief Act also suspended the casualty loss limitations for individuals.
Gift and Estate Tax Opportunities
For gift tax purposes, any individual may give any other individual accumulated annual gifts of up to $11,000 in value for 2005 and $12,000 for 2006 without gift tax consequences and without being required to file gift tax returns. A husband and wife could make separate gifts to a child in 2006 and transfer $24,000 tax free and without return requirements.
For 2005, each individual may make accumulated taxable gifts of up to $1,000,00 during their lifetime without paying a gift tax. This is on top of the amounts in the previous paragraph.
The applicable credit amount that an individual may pass at death (including previous taxable gifts) is $1,500,000 for 2005 and $2,000,000 for 2006. With careful planning, a couple may pass at least twice this amount tax free at death. Land and timber has a tendency to increase in value beyond our expectation over time, and it is a good thing to take a look at your plans from time to time.
Be sure to involve competent counsel for your planning and give 2005 some thought before it ends.
In the next article, we will discuss a question from a member and talk some about what is on the legislative foreground.
Happy Holidays and Merry Christmas!
Send Your Questions
We are interested in addressing your forest taxation questions in a future column. Please phone, fax, US Mail or E-mail them to:
Henry Barclay, III, C.P.A.
Lehmann, Ullman and Barclay LLP
2908 Clairmont Avenue
Birmingham, Alabama 35205
Phone: (205) 439-6520
Fax: (866) 824-8621
The material in Tax Tips is intended for educational purposes only and is not intended or directed or to be relied upon as
tax advice. Readers should consult with their tax advisor or attorney in considering the implication or application of tax law to their own individual circumstances.
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