Taxation

Paying federal, state, and local taxes is one of the responsibilities of forest land ownership. Taxes can have a serious impact on the profitability of timber production. Many forest landowners and even some tax preparers are unaware of the special tax provisions relating to forestry, and as a consequence, they pay more taxes than are required.

There are several key features of forest taxation. Each is important and forest landowners should have a basic knowledge of these features in order to pay the proper amount of federal and state tax. These features are briefly described below along with the MSU Extension publication which covers these topics.

Categories

The IRS categorizes forest landowners into hobby or personal use owners, business owners including farmers, and investors. These categories are based on the landowner’s profit motive and level of involvement in timber production. If there is no profit motive, the landowner is a hobby owner. Many forest owners file in the farm category, but unless the property is part of an active farm or is under a conservation reserve program plan, this is not advised. Instead, the proper category for nonfarm landowners involved in pursuing a profit through timber management is the business or investor category. Whether to choose business or investor depends on the landowner’s level of involvement.

For more information on this topic, please read the MSU Extension Publication, Timber Tax Overview.

Profit Related Expenses are Deductible

For landowners with a profit motive, ordinary, reasonable, and necessary expenses are deductible. The expenses must also meet what is called “industry standard.” This means that these expenses are the typical expenses that an industrial forest owner would incur in order to maximize profit from timber production.

For more information on this topic, please read the MSU Extension Publication, Timber Tax Overview.

Recordkeeping Is Vital:
In order to deduct expenses and to prove a profit motive, proper documentation is necessary. The IRS does not require any specific format, but records must be available in case of questions or audit. The IRS Form T: Forest Activities Schedule provides a template for recording capital investment into timber, that is, reforestation and other investment costs. 

For more information on this topic, please read MSU Extension Publication, Setting up the Books Using a Tree Farm Journal and Internal Revenue Service Form T: Forest Activities Schedule and Instructions for Form T available at www.irs.gov.

Knowing Basis Reduces Tax on Timber Sales and Allows Loss Deductions

Basis is the investment value of a capital asset, such as land, timber, or buildings. When land and timber is acquired, each asset has a basis which must be determined. Not every timberland acquisition results in a basis, but many do. The basis is important, because it affects the amount of tax due on a timber sale. Timber sales are taxed on net proceeds, that is, the gross proceeds less sales expenses and appropriate basis. The amount of loss which can be claimed from a casualty or noncasualty loss is also dependent on the basis in the timber. 

For more information on this topic, please read MSU Extension Publication, The Basics of Basis.

Timber is a Capital Asset

For most private forest landowners, timber is considered a capital asset, and when sold, must be reported as the sale of a capital asset, not as ordinary income. If the timber has been owned for the required period of time (a year and a day for purchased property), then the proceeds from the sale can be treated as a long term capital gain. Long term capital gains tax rates are the lowest tax rates available. 

For more information on this topic, please read MSU Extension Publication, The Basics of Basis.

Losses are Deductible, but only if there is a Basis

Timber losses are a possibility for all forest landowners. Weather, wildfire, disease, and insect infestation can destroy timber and make it unfit for sale. Depending on the cause of the loss, the loss can be claimed as either a casualty loss or as a noncasualty business loss. The amount of the loss deduction is limited to the loss in fair market value, as determined by a professional evaluation, or the amount of basis, whichever is less. If there is no basis, no loss can be deducted. 

For more information on this topic, please read MSU Extension Publication Frequently Asked Questions on Timber Casualty Losses and The Basics of Basis.

Reforestation is a Capital Investment

Investment in a new forest is an investment in a capital asset. Therefore, these expenses must be either capitalized, (recorded as timber basis and recovered when the asset is sold or claimed as a casualty or other loss) or recovered by using the special tax provisions in the federal and state tax codes. Under the federal code, up to $10,000 per year may be deducted for each qualified timber property. Any amount in excess of $10,000 may be amortized over seven years. Properties held in trust face special rules. In addition to using the federal rules, Mississippi landowners who pay income tax in Mississippi may claim a tax credit of up to $10,000 per year for qualified timber reforestation expenses on Mississippi lands. 

For more information on both the federal and Mississippi tax regulation on reforestation, please read MSU Extension Publication Paying for a New Forest.

Shade Tree Losses may be Deductible

Landscaping trees on a home site face the same natural hazards as forest trees. Involuntary destruction of shade trees by weather, fire, or other casualty may be deducted in certain circumstances. A professional evaluation of the loss is necessary and the loss is limited to a portion of the basis in the home.

More Information

USDA Forest Service's Forest Taxation web site provides non-industrial private forest (NIPF) landowners with a consolidated source of information on the complex tax issues associated with forest maintenance and management.

Timbertax.org on the World Wide Web has these publications and much more information, including relevant Internal Revenue Code sections, documents, and Revenue Rulings. Site author, Dr. Linda Wang of the USDA Forest Service, posts updates frequently.

Landowner, Forester, and Tax Preparer Education
MSU Extension Forestry holds Timber Tax Fundamentals I and II Short Courses throughout the year at various county extension offices and other sites. This six hour short course covers the basics of timber taxation relating to private forest landowners. Contact your local county extension director to see when a short course will be scheduled in your county or consult the short course calendar to find a short course nearby.

Frequently Asked Questions

FAQ's about Timber Casualty Losses