CHAPTER THREE

TAX CONSIDERATIONS

Federal Income Taxes

Federal tax codes relating to timber management and income are complex, and, at times, downright baffling. Any discussion of federal tax codes is risky simply because it is easy to say too much by starting the discussion in the first place, or too little by failing to flesh out the finer points applicable to specific situations. Serious woodland owners should always seek assistance from accountants or attorneys who are familiar with the subtleties of timber taxation.

For tax purposes, your woodlands will be treated either as a business or as an investment. A “gray area” exists in the tax code between what constitutes a business versus an investment, so which category is best or necessary must be determined for each owner on a case-by-case basis. Internal Revenue Service rules mandate the type of tax treatment that is required predicated upon the type of management, the owner’s participation, and methods and frequency of harvests. Tax advantages for treating your woodlands as a business include the opportunity to fully deduct ordinary operating expenses and depreciation, while investment income may offer long term capital gains benefits.

Timber accounts should be established when woodlands are acquired. Failing that, it is never too late to begin keeping detailed records. It is absolutely essential that separate records be kept for each individual stand beginning with determining the value, or basis, of the timber at the time of acquisition. The basis must then be periodically adjusted in each stand as timber sales are carried out.

It must be emphasized that one of the most common tax related errors made by woodland owners is failing to have the timber appraised when they purchase, inherit, or otherwise acquire property. In other words, they fail to establish their basis. Although it should seem obvious enough, when selling timber you need only pay income taxes on your profit. The only way you can know how much of a profit you made, if any, is by knowing what the timber cost you in the first place. Incredibly, people have purchased woodlands, sold all of their marketable timber a short time later, and paid income taxes on the entire amount of the sale proceeds!

Capital accounts are associated with real property, equipment, timber, roads, bridges, buildings, or virtually any other asset with a life span of more than one year. Woodland owners can usually, though not always, use capital costs to offset incomes through capitalization, depreciation, or depletion procedures provided they are directly associated with generating income.

It is important to realize that many ordinary expenses associated with managing your timber assets are deductible. However, costs of installing or maintaining associated benefits such as wildlife habitat or recreational projects may not be deductible unless it can be shown how these activities directly relate to some form of income, such as a hunting lease.

Preferential tax treatment is provided to landowners who incur expenses associated with planting trees or otherwise reforest their properties. Up to a $1000 tax credit may be earned in the first year when reforestation expenses are incurred. Tax credits are subtracted from your tax bill. Subject to certain limitations, additional reforestation expenses may be amortized for eight years. Woodland owners should always take advantage of reforestation tax incentives subject to the provisions of Public Law 96-451.

Foresters, accountants, attorneys, and the Internal Revenue Service may be able to provide you with excellent free or low cost publications regarding the Tax Code and timber income. Certainly, it would be to your distinct advantage to begin your own tax library.

Studying and attempting to comprehend the seemingly endless mysteries of the "infernal revenue service's" tax codes can be mind numbing for most people. That does not mean you should be completely brain dead. Having first hand knowledge of a few basic tax considerations could very well prevent you from over-paying your federal income taxes, and substantially increase profits from your woodland investments.

Estate Planning

Like it or not, sooner or later we all become a decedent. In Tennessee, becoming a decedent is officially defined as being "deader than a door nail." What provisions, if any, have you made towards including your woodlands as part of your estate? Whatever ultimately happens to your land, your trees, and your dreams should not be left up to the courts, to the IRS, or to chance.

Woodland owners have an opportunity to establish a unique, and very profitable family business that can be passed from generation to generation. So, the importance of estate planning cannot be over-emphasized. Properly designing your estate to cover all contingencies is no simple task, and should not be put off until you "get around to it." The fact of the matter is, few people plan their estates properly, if at all. So, less than one-half of all family-owned businesses are inherited by even the very next generation. Through each succeeding generation, the odds for a family business to survive diminish even further.

An in-depth discussion of estate planning options and associated tax liabilities far exceeds the scope of this writing. Never the less, this important consideration seriously affects long term financial benefits for you and your family. Because of the long rotation lengths necessary for most timber investments, maximum profits from diverse woodland portfolios cannot be achieved during any single individual's lifetime. Therefore, maximum returns can only be realized and sustained if managed woodlands are passed along intact as a legacy from one generation to another. In fact, the business should become more profitable with each succeeding generation.

Many estate options are available. You may have concerns about your retirement, protecting the interests of your spouse or beneficiaries, determining who will manage your woodland assets after you are gone, or any number or combination of factors. However, the planning and final decisions are entirely up to you. A qualified financial, or estate planner can offer advice on which course of action can best meet your needs. But, don't leave it up to your family to decide what is best after you are gone. If you truly intend to develop a woodlands portfolio, don't leave the most important part undone.

By properly developing an estate, it is possible to preserve your woodlands portfolio for generations to come. Failure to properly plan your estate could force your beneficiaries to liquidate the entirety of your carefully crafted timber and land assets.

Property Taxes

In Tennessee, the Comptroller of the Treasury, Division of Property Assessments has responsibility for developing statewide appraisal standards for woodland properties. These standards are applied locally by County Property Assessors to determine individual tax liabilities.

Crops, including tree crops, generally cannot be taxed in Tennessee. However, rural land is appraised for tax purposes on the basis of potential productivity. Woodlands are broken into Good, Average, and Poor categories, plus several sub-categories. Good woodlands are taxed at a rate higher than the two lower categories. Therefore, taxes are based upon the inherent capabilities of the land for producing crops of trees, not the value of the trees themselves. So, a wise manager that maximizes woodland income should pay the same property taxes as a poor manager with comparable land.

A special category exists for lands designated for pine pulpwood production. Again, several sub-categories apply.

Property values, or fair market values may be established by County Property Assessors on the basis of what they consider to be the "highest and best use" on given tracts of land. Their determination might or might not be consistent with the "current use" or goals you established for your property. For example, a wooded tract near an urban center might be considered prime development property and taxed on that basis. However, if the ownership goal is to continue to manage the land for woodland values then the owner could face paying inflated property taxes. To counter that possibility, Tennessee enacted the “Agricultural, Forest, and Open Space Land Act of 1976, better known as the “Greenbelt Law,” to protect qualified woodland owners with long term goals. You must sign up for the Greenbelt program at the County Courthouse by April 1, or the day the County Board of Equalization is adjourned in a year of reappraisal. A written forest management plan for your property prepared by a forester may be required.

It is important to know how your property is being assessed. Remember, Property Assessors are not foresters. Discuss your tax rate with your Property Assessor and find out how your property was appraised. Many owners might very well reduce their property taxes by enlisting in the Greenbelt program.