This is a complex issue with numerous ramifications, pitfalls and planning opportunities. Note, the following is merely an overview and professional tax advice is highly recommended.
Generally, your forestry consultant or the timber buyer will issue you a Form 1099 which reports your timber sale proceeds to you and to the Internal Revenue Service. Where this amount goes on your tax return and your deductions against this income depends on your personal situation.
In general, there are two principal means of reporting timber sale proceeds and therefore how timber is held.
The first, and probably the easiest to understand, is when the taxpayer is considered an investor and is not in the trade or business of selling timber. As an investor the sale proceeds are reported as the sale of a capital asset on Schedule D (Long or Short Term Capital Gains). From the sale proceeds you can deduct your cost basis and expenses of the timber sale. The net proceeds are then taxed as either Long Term or Short Term Capital Gains, depending on how long you have owned your timber.
The other means is more complex, but as is often the case with the IRS, more advantageous to the taxpayers that are able to qualify and seek this option. In this situation the timber is held as a trade or business and the taxpayer makes a valid Section 631 election. The advantage of this approach is that timber sale proceeds, net of basis, are taxed at Capital Gain rates and the expenses are deducted against ordinary income. BUT, there are a number of requirements that MUST be met and maintained, one of which is that you must be active in the business. This active is a critical concept and one that requires professional advice.
Finally, what is Form T?
Form T or the Forest Activities Schedule was designed by the IRS to provide information on timber accounts. While Form T may be required for Section 631 timber sales, much of the data and procedures apply to timber sold as a capital asset. While the Form appears overwhelming a step by step review makes the thought process much more understandable.
One of the primary deductions against any timber sale and one of the calculations on Form T is the taxpayer’s cost basis in the standing and harvested timber. In our next article we will discuss basis and where it comes from.
In the meantime feel free to contact the folks at FORECON, Inc. for your forestry and timber related issues.