Now that April 15 has come and gone, taxes have receded to the back of our minds. Unfortunately, if we want to take full advantage of our tax system, taxes need to be a routine chore -- just like making the beds or washing dishes. Many forest owners miss out on deductions because they do not keep records. Even small expenses, if directly related to profit potential, may be deducted, as long as adequate records are kept.

Record keeping

The IRS does not require any specific record-keeping system. If you are comfortable with computers, there are many software packages that can be used to record expenses and use them for tax purposes. There is no special timber taxation software program, although, the folks who keep up www.timbertax.org are working on it. Their goal is to create a system to keep timber records and produce the necessary forms, including Form T: Forest Activities Schedule for easier timber tax filing.

Most timber tax record keeping is the same as for any other business or investment. A good guide for small businesses is the free IRS Publication 535: Business Expenses. This can be downloaded from the www.irs.gov Web site or ordered from the IRS Hotline at 800-TAX-FORM (800-829-3676.) Investors deduct these expenses as miscellaneous itemized deductions and business owners deduct them as business or farm expenses, using the correct form for their business structure. If the investor is taking the standard deduction or just chooses to do so, he can capitalize them into his timber basis account. This means, they are recorded into the timber basis account and used to offset timber sales income. (If you don’t know about timber basis, you may wish to order a free publication called “The Basics of Basis” from the Mississippi State University Extension Forestry office at 662-325-3905 or download it from www.msucares.com.)

Reasonable and necessary

The IRS determines what expenses are reasonable and ordinary by looking to industry standards -- that is the customary practice of forest industries such as Weyerhaeuser or timberland investment management organizations (TIMOs) such as Hancock Timberland Investment Group. Such practices as herbicide application, fertilization not associated with reforestation, management plan preparation, boundary line marking, prescribed burning, fire lane maintenance, record keeping, office expense and road maintenance are all reasonable expenses of forest management.

Travel expenses

Reasonable travel costs related directly to the income potential of the property are deductible -- after all one needs to periodically check lines and perform management work on the property. Record the odometer readings and purpose for each business use to determine the correct deduction as directed in IRS Publication 463: Travel, Entertainment, Gift, and Car Expenses.

Remember to distinguish between pleasure trips and business trips. A trip taken to walk the boundary lines, to apply herbicide, check survival of young timber, check for insect or weather damage is deductible. A trip to clean out the cabin and fish in the pond is a pleasure trip and is not deductible. Sometimes business and pleasure may be combined, but make sure that deducted mileage is for legitimate business purposes.

Operating and capital costs

It is important to distinguish between operating expenses and capital expense because capital costs are treated differently. Operating costs are deducted each year. Capital costs are recovered when the asset is sold, a loss is taken, or a vehicle or piece of equipment is depreciated. The cost of establishing a new forest -- either by natural or artificial regeneration -- is a capital cost and landowners must follow special rules to deduct these costs. Other capital costs include permanent road construction, drainage structures, pruning, and of course purchases of equipment such as a tractor or pickup.

For landowners with extensive acreage, it may be necessary to purchase a vehicle for use on the forest, instead of using one’s personal vehicle and deducting mileage. In that case, the cost of the vehicle may be depreciated and operating expenses deducted. Of course, records must be kept on actual use and costs allocated between business and personal use, if any.

To buy or not to buy?

To make the decision as to whether a piece of equipment is necessary, determine if the purchase of the equipment will pay -- what are the expected returns with the purchase of the equipment and without the equipment? If the equipment is not purchased, what is the cost of contracting out the practice? Remember to include the effects of depreciation and sale of the equipment, if applicable, in the analysis.

 

Equipment is not the only business expense that is depreciated. Capital assets which have a determinable life are depreciated over that life. Culverts, bridges, fences, buildings, temporary roads, surfaces of permanent roads are all depreciable assets. These assets are depreciated using the Modified Accelerated Cost Recovery System called MACRS. MACRS divides tangible personal and real property into classes. Each class has a specified recovery period, over which the asset is depreciated.

IRS Publication 946 How to Depreciate Property can be very helpful to family forest owners. Along with routine deprecation information, it includes information on the Section 179 program, which allows small businesses to take additional depreciation on equipment in the first year of service, if the equipment is used at least 50 percent for business. If the equipment is used for both personal and business use, then records must be kept to determine the correct proportion of depreciation that is deductible.

Capital gains update

In January, 2008, the long-term capital gains rates dropped to 0 percent and 15 percent. These rates will apply through 2010 unless Congress passes changes in the law. The 0 percent rate only applies to the part, which if added to ordinary income would be taxed at the 10 percent or 15 percent marginal tax rate. What is the 10 percent or 15 percent marginal tax rate? In 2008, the upper limit is $65,100 for a married couple filing jointly, $32,550 for an unmarried taxpayer or a married taxpayer filing separately, and $43,650 for a taxpayer who is head of household. Dr. Bill Hoover of Purdue University has written an excellent article for Tree Farmer Magazine explaining how the two rates are applied. This article, titled “Will the Zero Percent Capital Gains Rate Help You?” has been posted on the www.timbertax.org Web site under “Publications” and then under “Tax Articles.”

The kiddie tax

Taxpayers may wonder if they may give their timber to their children and have the children sell the timber to access the lower capital gains rate. There are limitations on doing this, called the “kiddie tax.” If a child is 18 or younger (up to age 23 if a full time student) he or she can only get the 0 percent capital gains rate on investment income of $1,800 or less. Any investment income over that amount will be taxed at the parent’s top rate.

Gifts of timber or timber income

Remember that gifts of timber or cash must be reported if the value is over $12,000 ($24,000 if a gift of husband and wife). If you want your children to receive the payment for timber from the timber buyer, then gift the timber to them before the timber sale, so they own the timber and can legally sell it and accept payment. The seller of the timber is responsible for paying tax on the timber sales income. The gift of timber or cash and the sale of timber are two separate taxable events.

Legislative prophesies

For years, landowners have been pushing for the elimination of the estate tax, reductions in capital gains rates, and lower income tax rates. Given the current financial strain of our nation, it is not likely that this can or should happen. The current federal debt (not including the cost of the Iraq war, which is off-budget) now amounts to more than $30,000 for every man, woman and child. Our unfunded liabilities are even more depressing -- for various programs such as Medicare Parts A, B, and D and Social Security, the total is over $175,000 per person according to former Comptroller General of the United States David Walker. According to Walker, we cannot grow our way out of this problem -- that would require double digit growth for the next 75 years. Balancing the budget in 2040 would require 60 percent cuts in all federal spending or taxation at double today’s rates.

Given these realities, it is unrealistic to expect that Congress will totally eliminate estate taxation. In order to reduce the burden of estate taxes on small businesses, farms, and family forests, they may choose to raise the estate tax exemption. Few family farms and forests would be faced with liquidation to pay taxes if top rates were set at a reasonable ceiling and then indexed for inflation. Proper planning, including the use of life insurance, trusts, or business structures, can be used to prepare for the estate tax burden.

Long-term capital gains rates are at their lowest rate in years. These low rates expire in 2011 and all bets are off as to what decisions the Congress will make about extending the low rates.

If you would like more information on Walker’s fiscal warnings, go to www.gao.gov and check out the Comptroller General Presentations. Although it is not pleasant to face the reality that our governmental spending cannot be sustained at the present level without significant tax increase, we cannot continue to push the burden onto future generations.

Beth Richardson is an agent with the Clemson Extension Service in Orangeburg County. This article was originally published in Capital Ideas, The Newsletter for the Alabama Forest Owners’ Association Inc. and was reprinted with permission. The Alabama Forest Owners Association Web site, including Capital Ideas-Live!, an archive of online forestry news conferences with leading forestry experts, is found at www.AFOA.org.

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