Timber Tax basis, how does it work?
Establishing a Timber Tax Basis
For forestry landowners, understanding the timber tax basis is essential for effective financial management and tax planning. This article explains how to establish a timber tax basis, provides illustrative examples, and details the process of back cruising. We will also discuss the tax implications of receiving gifted property and the advantages of long-term capital gains tax rates.
What is a Timber Tax Basis?
Timberland value consists of two primary components: bare land and standing timber. The investment in each of these components is referred to as the "tax basis." It is vital to establish the timber tax basis as soon as possible after purchasing or inheriting property. In the case of inherited property, a "stepped-up" basis is assigned to the fair market value appraised at the time of the decedent’s death. By determining the timber's tax basis, landowners can sell timber and only pay taxes on the increase in its value due to growth, inflation, or market changes.
Establishing the Timber Tax Basis
It is important to account for standing timber and raw land separately. Here is an example to illustrate the process:
Example: In 2017, Ms. Johnson purchased 80 acres of forested land for $300,000. The property included a 40-acre stand of 20-year-old white oak. Her consulting forester appraised the timber at $100,000 (timber tax basis) at the time of purchase. In 2022, Ms. Johnson decided to sell (clearcut) the stand. After her consultant managed the sale and obtained competitive bids, Ms. Johnson received $140,000 in net revenue (sale price minus sale expenses).
To calculate her taxable gain, Ms. Johnson’s accountant subtracted the timber basis from the net sale price:
Taxable Gain=$140,000−$100,000=$40,000
If the timber sale had been a partial harvest (thinning or selective harvest), only a proportionate amount would have been deducted from the timber tax basis, resulting in no taxes. (No gain)
The depletion of her timber tax basis reduced her overall land and timber tax basis by $100,000. If she were to sell the property following the harvest, she would pay capital gains tax on any sales amount over her new adjusted tax basis ($200,000 for the remaining raw land). This is still better than paying taxes on the timber as you can then do a 1031 into another piece of property and defer the taxes once again.
Back Cruising
If Ms. Johnson had not established a timber tax basis at the time of purchase, she could have had her consulting forester perform a back cruise. A back cruise estimates the present timber volumes and regresses growth to the time of purchase. These estimated quantities are then multiplied by historical timber prices to determine the acquisition value. Note that tax law prohibits back cruising once the trees have been cut, meaning you cannot legally retroactively establish harvest volumes.
Gifted Property
When property is received as a gift, the recipient also receives the giver’s tax basis values. Before gifting or accepting property, it is essential to consider the tax implications. Often, gifted property was acquired by the giver many years ago, resulting in a nearly zero timber tax basis. Tracts acquired long ago are challenging to back cruise due to extensive growth and mortality over the years.
For more information on timber taxation, visit:
Understanding and accurately determining your timber tax basis allows you to make informed decisions that benefit both your forest and your financial well-being. If you need assistance with a back cruise or any aspect of timber taxation, our forestry consulting services are here to help.