Updates to AG Handbook 718: Forest Landowners’ Guide to the Federal Income Tax
December 9, 2004
Deborah A. Gaddis, Associate Extension Professor
and Stephen G. Dicke, Extension Professor
Mississippi State University
Department of Forestry
Mississippi State, MS 39762
Since Agricultural Handbook 718 was written, there have been two significant tax laws passed by Congress and signed into law. The first law was the Jobs and Growth Tax Relief Reconciliation Act of 2003, which reduced the capital gains rates to 5% and 15% and changed the marginal tax rates. The second significant law was signed into law on October 22, 2004. The American Jobs Creation Act of 2004 had significant effects for forest landowners, including the elimination of the federal reforestation tax credit, deduction of the first $10,000 in reforestation expenses, and improvements in amortization of reforestation expenses. It also improved the ability of business owners to claim capital gains on timber sales.
Although these changes have made some portions of Agricultural Handbook 718 obsolete, it still remains a valuable resource for forest owners and tax professionals serving them. It is expected that a revision of Ag. Handbook 718 will be undertaken in 2005. Until that time, Mississippi State University Extension Service will continue to use Ag. Handbook 718 as a resource for timber tax education. This correction sheet should alert readers to the changes in timber tax and should be permanently attached to Ag. Handbook 718. Further information may be obtained from MSUcares.com or from www.timbertax.org.
Chapter 5: Cost considerations. Please note that the examples utilizing Form T are using an out-of-date Form T. Form T was revised in October 2003. The new Form T is shorter and has 5 parts: Part I Acquisitions, Part II Timber Depletion, Part III Profit or Loss from Land and Timber Sales, Part IV Reforestation and Timber Stand Activities and Part V Land Ownership. Investors are not required to use Form T—however, they are required to have adequate records as explained in the form’s instructions. Use of Form T is required for claiming Timber Depletion. Part IV can be used to inform the IRS of the election to amortize reforestation expenses.
1st full paragraph. The recovery of reforestation expenses by being amortized is not limited to $10,000 after October 22, 2004. After that date, taxpayers may deduct the first $10,000 in reforestation expenses and amortize all remaining expenses over 84 months.
P. 26: Reforestation Tax Incentives. After October 22, 2004 no federal reforestation tax credit exists.
P. 28: Amortization. After October 22, 2004 the taxpayer may deduct the first $10,000 in reforestation expenses. An 84-month amortization is allowed for all expenses above $10,000. One-fourteenth can be deducted the first year. One-seventh deducted years 2 through 7 and one-fourteenth the final year.
Investors subtract the reforestation deduction and amortization from gross income on the front of Form 1040. Business owners (sole proprietors) take the deduction and amortization as “other expenses” on the first page of Schedule C. Farmers report these as “other expenses” on Schedule F. Taxpayers will still need to elect to amortize on a timely filed return. The IRS can be informed of the election to amortize by using a plain piece of paper or on Part IV of Form T (Timber) Forest Activities Schedule.
P. 29: The Tax Credit does not apply for expenses incurred after October 22, 2004.
P. 29-35: Depreciation and the Section 179 Deduction. Several tax laws have changed these rules. Please see a current copy of IRS Publication 946 How to Depreciate Property for the current rules and restrictions, which apply to Section 179 and Bonus Depreciation. You may obtain a copy of Pub. 946 from www.irs.gov or call the IRS hotline at 1-800-TAX-FORM (1-800-829-3676).
Chapter 6: Income Considerations. In 2001, long term capital gains rates were reduced to 15% and 5%. The 5% rate applies to income, which if added to ordinary income, would be taxed at the 10% and 15% marginal tax rates. These rates are scheduled to increase under current law in 2008 and 2009.
All timber sold after December 31, 2004 qualifies for capital gains as long as the required holding period is met. Even timber held by a business and sold as a lump sum meets the requirement of selling timber "with a retained economic interest." The best explanation for this comes from www.timbertax.org:
(1) Capital gains treatment for timber "held primarily for sale to customers in the ordinary course of a trade or business", or for use in a trade or business
Under current law [on 12/09/04] timber "held primarily for sale to customers in the ordinary course of a trade or business," or for use in a trade or business, that is disposed of on the stump must be done so under a so-called "pay-as-cut" contract to qualify for long-term capital gains treatment. In tax lingo it must be "disposed of with an economic interest retained." The bill amends Internal Revenue Code (IRC) Section 631(b) to provide that the disposal of timber on the stump qualifies for capital gains treatment if sold with either a pay-as-cut, or a lump sum contract. Lump sum is the type of contract generally preferred by landowners because the total amount to be received from the buyer is fixed in advance, rather than depending on the volume actually harvested by the buyer. Effective date: Sales after December 31, 2004.
Example under current law [on 12/09/04]. Mr. Jones has operated a 350 acre tree farm in Georgia since 1974. He uses Form 1040, Schedule C, Sole Proprietorship business form, to report his tree farm incomes and expenses. In November 2004 he offers 80 acres of sawtimber timber for sale. He has sold timber 7 times since 1974. Because he operates as a business and has made frequent sales, he tells buyers that he must use a pay-as-cut contract in order to receive capital gains treatment. This limits the buyers he accepts offers from because he must trust them to accurately scale the logs produced and report this volume to him. He is paid based on the volume cut and the price per unit specified in the contract.
Example under revised law: Assume the same circumstances as in the above example, except that Mr. Jones tells buyers that the sale will be closed January 2, 2005. He also tells them to offer him a fixed dollar amount for the timber on the 80 acres. He asks for 50% of the proceeds at the time of signing and 50% before logging starts. This "lump sum" sale qualifies for long-term capital gains treatment, even though the timber is part of a business.
Please remember that the examples in Chapter 6 are based on the old Form T. The new Form T has different headings for each section. In addition, to claim depletion of the timber basis, Form T is REQUIRED and not optional. Do not use a plain piece of paper to claim depletion of timber.
P. 56. Last paragraph, election under Section 631(a) may now be made on a year-to-year basis. From www.timbertax.org comes this explanation:
(3) Revocation of existing election to treat a cutting of timber as a sale
Under current law timber owners who cut their own timber or have it cut under a logging services contract can receive capital gains treatment on the value of the stumpage cut by electing to treat the cutting as a sale under IRC Sec. 631(a). Once made, this election is binding on all future timber cut by the taxpayer. The bill provides that an election by a corporation made for a taxable year ending on or before the date of enactment of the bill, to treat the cutting of timber as a sale or exchange, may be revoked by the taxpayer without the consent of the IRS for any taxable year ending after that date. The prior election (and revocation) is disregarded for purposes of making a subsequent election. This change apparently applies only to corporations. Effective date: October 22, 2004
Chapter 8: Casualties, Thefts, and Condemnations. Reforestation provisions of the American Jobs Creation Act of 2004 may affect the amount of losses claimed. Details have not been provided by the IRS at this time.