Authored by: Dr. Yanshu Li The short answer is: It depends. The slightly longer answer is that it is determined by the classification of your timber holding, the way to sell the timber and your modified adjusted gross income for the net investment income tax purposes. What is the net investment income tax? The net investment income tax, also known as the Medicare surtax, is an additional tax applicable to high-income individuals, estates and trusts with significant investment income. More specifically, it is a 3.8% tax on the lesser of: Net investment income or The excess of modified adjusted gross income over a threshold ($250,000 for married filing jointly and $200,000 for single taxpayers). The tax went into effect in 2013. Generally, net investment income includes: Interest, dividends, capital gains, annuities, royalties and rents not derived in a trade or business and Income from businesses that are passive activities to the taxpayer. Wages, unemployment compensation, operating income from a nonpassive business, Social Security benefits, tax-exempt interest and self-employment income are not subject to the NIIT. Timber income and the net investment income tax For federal income tax purposes, your timber activity generally can be classified into one of three categories: For investment Material participation in a trade or business Passive activity where your participation in a trade or business does not rise to the level of material participation Due to the level of involvement, most private family forest landowners fall in the investor category. A common example of passive activity in timber business is the limited partner in a partnership. For investors, income on the sale of standing timber is a capital gain. Depending on the holding period, it can be long-term or short-term, but it is usually included in the net investment income for net investment income tax. If you materially participate in a timber trade or business, your timber income is not subject to this tax, even if it is treated as a long-term capital gain (e.g., held longer than one year and sold under a lump-sum sale or pay-as-cut contract). However, it is subject to the tax if your timber activity in a trade or business is passive and your modified adjusted gross income is over the threshold. Strategies to manage the net investment income tax for timber owners If you can substantiate your timber activity as material participation in your timber business, you can enjoy the long-term capital gains tax treatment of your timber income and won’t have to worry about owing the net investment income tax on it. However, your timber income may push your modified adjusted gross income over the threshold and trigger the net investment income tax on non-timber investment income. Therefore, you may want to manage the timing of your other investment income when you expect to have a significant timber income. Download this document for more information about timber taxation. This is for informational and educational purposes but not intended as financial, tax, or legal advice. Please consult with your tax advisor concerning your particular tax situation.
