Controlling Your Timber Sale Tax
value, and then multiply this decimal by the purchase price of the timber to get the original cost basis.
Between the time that the timber assets are acquired and when they are sold could be several years. So what happens to the basis over time? It changes. The inventory volume in each account will grow each year, or it might be reduced as a result of mortality from ice damage, fire, or forest pests/disease. It may be necessary to conduct another inventory right before a timber harvest in order to determine just how much volume is in each account.
So why make all of these calculations and keep records? We do it so that we can recover the cost basis in our timber account at the time we sell our timber. From the actual timber sale revenue we can subtract the cost basis in our timber account based upon the volume we have harvested from the account.
Here's an example to demonstrate how this is done. Suppose you acquire a property for $165,000 purchase price. You also incur additional costs of $1,500 to hire a forester to complete a timber inventory, $2,000 to have a boundary survey, and $1,000 for closing costs. The total acquisition cost is then $169,500 ($165,000 + $1,500 + $2,000 +$1,000). The total appraised value of the property at the time of purchase was $159,000 (not the purchase price), which included buildings, fence, merchantable walnut sawlogs, mixed oak-hickory sawlogs, bare land, and a young (non merchantable) tree plantation. Furthermore, let's assume that the forester's inventory lists 19 MBF (thousand board feet) of walnut veneer logs valued at $20,330.
To continue calculating your cost basis in the walnut veneer log account, use the following procedure:
1. Divide the inventory value of the walnut veneer logs ($20,330) by the total appraised value of the property ($159,000) to get the proportionate value of this asset as a percentage of the total.
($20,330 divided by $159,000 = 0.1279).
2. Multiply this decimal (0.1279) by the total purchase price ($169,500) to get the original cost basis for the walnut veneer logs.
($169,500 x 0.1279 = $21,679.05)
You would want to follow this procedure for each of the merchantable timber products identified in the inventory when they are sold or harvested.By making these calculations, we can recover our cost basis in the timber account when the timber is harvested or when the logs are cut from the timber and sold or used in the owner's business. This process of recovering our cost basis is called depletion.
In order to calculate depletion, we first need to figure the depletion unit rate so that we can determine the depletion deduction allowance. To calculate the depletion unit rate, divide the original or adjusted basis (if the timber has grown or changed in some other way over time) by the current volume in the account. In our example, we divide the original cost basis of the walnut veneer logs ($21,679.05) by the volume (19 MBF) to get a depletion unit rate of $1.14 per board foot ($21,679.05 divided by 19,000 bf = $1.14 per bf).
To continue our example, if you sell 10 MBF of walnut veneer logs immediately after purchasing the property, then your depletion deduction allowance is $11,400 ($1.14 per bf x 10,000 bf). If you have waited a year or more from the purchase date, then the volume in the walnut veneer account would grow by some growth factor that would reflect the rate of growth of the trees and the number of years since acquisition.
Federal income tax for our example would be paid on the net taxable gain as shown below:
Gross gain from timber sale:$20,000
Consulting forester fee ($ 2,000)
Depletion deduction Allowance ($11,400)
Net taxable gain: $ 6,600
If you fall into the 28% federal income tax bracket, your action of establishing the cost basis in your timber saved you more than $3,700 in tax liability because you pay tax on $6,600 instead of the $20,000. How many forest landowners pay taxes on the gross gain each year? There are questions as to whether or not this is a capital gain. The determination of this point is made based upon your objectives for ownership of the property, length of time between purchase and sale of timber, and whether or not you meet certain material participation criteria.
Contact a consulting forester or public agency forester if you are interest in completing an inventory of your timber. It is the first step to realizing significant tax savings on timber income.