Basis and Depletion
This is the pitfall that can lead to problems. Timber accounting is depletion accounting, like that used for oil, gas and minerals. With the exceptions listed above, timber must be treated as a capital asset and its purchase price capitalized.
Basis. The total cost of purchasing forestland (or the value of inherited forestland) must be capitalized, with values allocated to land, timber, improvements, buildings and other relevant capital accounts. The value allocated to each asset is its basis. This allocation must be based on the fair market value (FMV) of the assets. Total purchase price is allocated to each asset based on its current FMV at the time of purchase.
Example: You purchase a forest property for $200,000 (including legal costs, surveying costs, appraisal and timber cruising costs, and transaction costs, all of which must also be capitalized). It includes timber, land and a building. The appraisal finds the timber is worth $132,000, the land is worth $66,000 and the building is worth $22,000.
The allocation must be based on these FMVs and is calculated as follows:
Account FMV %FMV Basis
Timber $132,000 0.60 $120,000
Land $66,000 0.30 $60,000
Building $22,000 0.10 $20,000
$220,000 1.00 $200,000
Depletion. The basis of timber is adjusted up for new purchases and it is adjusted down for sales or disposals of timber. That is, the capitalized amount can only be deducted against timber revenue (short of a casualty loss like a fire). This deduction is called a depletion allowance and must be in proportion to the amount of timber cut. Keep in mind that the amount of wood on a timber tract is almost always increasing. Trees grow. Depletion must be calculated based on total timber volume on the tract at the time of harvest. Depletion is usually calculated as a rate.
Example: In the example above, the timber purchased was 440 MBF (thousand board feet) worth $300/MBF. Three years later, when the timber volume has grown to 500 MBF, the forest owner contracts to sell 220 MBF for $350/MBF, or $77,000. First, a depletion rate is calculated as $120,000/500 MBF = $240/MBF. Then, a depletion allowance is calculated as 220 MBF X $240/MBF = $52,800. Another way to think about it is that 44% of the timber was harvested, so the depletion allowance is 44% of $120,000. Then the taxable capital gains income is $77,000 - $52,800 = $24,200.
Pitfall. It is common for a forest owner not to perform the basis allocation calculation at the time of purchase or inheritance. Years later, the accountant needs basis information to calculate depletion allowance. It is costly to hire a forester to determine the likely timber volumes and values for what might be decades in the past. All forest owners are required to perform the allocation or lose the chance for a depletion allowance. This is part of required IRS timber records. There is even a form, Form T (Timber) to report adjustments to basis and timber depletion. Many accountants have never heard of it.
www.timbertax.org
Anything you ever wanted to know about timber taxes is on the web at www.timbertax.org. This extensive site covers new changes to the tax law, timberland acquisitions, structuring ownership, timberland appraisal, basis, depletion, costs, depreciation, casualty losses, state timber tax laws, estate planning and tax research. It is by far the single best source of timber tax information in the country.
Thomas J. Straka is a forest economist at Clemson University in South Carolina.