Many forest landowners think about taxes only after they had a timber sale. However, careful tax planning is essential to minimize your total taxes considering the long-term nature of forest management and the availability of a few income tax provisions related to timber.
Here are 9 tax tips for forest landowners:
1. Know the classification of your timber holding
Your timber holding largely determines the type of your timber income, associated tax rates, applicable rules for expense and loss deduction, and tax filing requirements. It normally could be classified as one of the following three types: 1) property for personal use or as a hobby (not-for-profit); 2) property held as an investment; or 3) property held in a trade or business.
2. Understand timber sale income and capital gains tax
When you have a timber sale, you pay federal income taxes on the net income rather than the gross proceeds. You can subtract selling expenses, timber depletion allowance, and yield tax from the revenue to get the net taxable gain. In most cases, your income from a standing timber sale is taxed at the favorable long-term capital gains tax rate (0%, 15%, or 20% depending on your taxable income) if you have owned it for more than 1 year. Inherited timber automatically meets the long-term holding period requirement.
3. Take advantage of the reforestation tax incentives
You may deduct up to $10,000 qualifying reforestation expenditures per year per qualified timber property and amortize the rest over 84 months. The deduction is an above-the-line deduction and is deductible against other sources of income.
4. Recover operating expenses and carrying charges
If you materially participate in your timber business, you can fully deduct ordinary and necessary expenses associated with carrying on the business. For 2018 through 2025, timber investors are not allowed to deduct eligible operating expenses through itemized deductions but may consider capitalizing certain forest management expenses and carrying charges with proper tax elections. You can still fully deduct timberland property taxes if you itemize.
5. Keep track of your timber basis
Timber basis is generally the amount of capital investment in your timber. If the forestland was purchased, the original timber basis is the amount of your total acquisition costs allocated to the timber. If the property was inherited, the timber basis generally is its fair market value on the decedent’s date of death. If the property was received as a gift, the basis is generally the donor’s basis plus the gift tax.
6. Claim timber casualty loss deduction when natural disaster hits
Timber loss caused by a casualty event (e.g., hurricane, storm, fire) may be tax deductible. You may deduct the lesser of the basis or the decrease in the fair market value of your affected timber block caused by the casualty.
7. Consider excluding cost-sharing payments
Some conservation-oriented cost-sharing payments from qualified government programs qualify for income exclusion.
8. Take advantage of the Qualified Business Income (QBI) deduction if applicable
If your timber business has received ordinary income from selling cut timber products, pine straw, live trees, or other products, you may consider taking the QBI deduction. It is available for tax years 2018 through 2025.
9. Smooth out your timber income over years
You may consider using an installment sale approach (lump-sum contract) or a pay-as-cut contract to smooth out your timber income over several years if such arrangement can minimize your total taxes.
Timber taxes are often very complicated. Please consult with your tax advisor regarding your particular tax and financial situation.