Food, Conservation, and Energy Act of 2008
(P.L. 110-234, H.R. 2419)
The House on May 21 and Senate on May 22 overrode President Bush's veto of the "Farm Act." The Food, Conservation, and Energy Act of 2008 (Act) puts into effect many tax provisions of interest to timberland owners with an effective date of May 22, 2008. Some provisions may directly impact their tax liability, while others may impact timber markets and conservation organizations. Several provisions applicable to "farmers" only are included for farmers who also grow timber.
15% Tax Rate for Corporate Timber Capital Gains For One Year
The capital gains of C corporations, including those on timber, are subject to the same tax rate as ordinary income, up to a maximum of 35%. Corporations qualify for timber capital gains under the same provisions as any other taxpayer: (1) elect to treat a cutting as a sale or exchange eligible for capital gain treatment under Code Sec. 631(a), and (2) Disposal of timber with a retained economic interest retained or makes an outright sale of the timber under Code Sec. 631(b). In both cases the taxpayer must have owned the timber or held the contract right for a period of more than one year to be eligible.
The Act provides a 15% tax rate for corporations on the portion of taxable income that consists of qualified timber gain (or, if less, the net capital gain) for a tax year. Qualified timber gain is the same as under current law, but is restricted to gains on trees held more than 15 years, Code Sec. 1201(b), as amended by Act Sec. 15311(a)). The 15% rate also applies to the alternative minimum tax.
The 15% tax rate for qualified timber gains of corporations applies only to disposals of timber beginning on May 22, 2008 and before May 22, 2009 (Code Sec. 1201(b)(1) If a corporation's tax year includes the enactment date, qualified timber gain can't exceed the qualified timber gain for the portion of the year after that date. If a tax year includes the date that is one year after the enactment date, qualified timber gain can't exceed the qualified timber gain properly taken into account for the portion of the year on or before that date (Code Sec. 1201(b)(3)).
REITs Holding Timber Get Expanded Capital Gains Treatment
Real estate investment trusts (REITs) became a major vehicle for holding timberland when integrated forest products firms restructured, due in part to the lack of a differential tax rate for corporate capital gains. The Code's treatment of REITs, however, did not reflect the manner in which income is derived from timber operations. The Act continues adjustments necessary to bring timber REITs in line with more traditional real estate holding, such as rental property. In general, REITs must derive most of their income from passive real estate activities. Critically important, they can deduct dividends paid out and can declare capital gains dividends that are taxed at the shareholders' individual capital gains tax rate. IRS has ruled that income from the sale of trees under Code Sec. 631(b) can qualify as REIT real property income. But, this limited the ability of REITs to dispose of timber in the manner providing the greatest return at any particular location and point in time.
A 100% excise tax is imposed on a REIT's gain from sale of property held for sale to customers in the ordinary course of business. There is a safe harbor from this tax if certain conditions are met. Timber property meets the safe harbor, regardless of the number of sales that occur during the tax year, if (1) the REIT has held the property for not less than four years in connection with the trade or business of producing timber; and (2) the aggregate adjusted bases of the property sold during the tax year does not exceed 10% of the aggregate bases of all the assets of the REIT as of the beginning of the tax year.
The Act expands the ability of timber REITs to receive capital gains treatment by including the election to treat a cutting as a sale, Code Sec. 631(a), and creates a new entity for tax purposes called a "Timber REIT."
Timber gain as qualified REIT income -- Qualified real estate income of a REIT includes (a) timber gains under Code Sec. 631(a) if the cutting is provided by a taxable REIT subsidiary (TRS), as well as gain recognized under Code Sec. 631(b). Both types of gain are included whether or not the otherwise applicable one-year holding period is met (Code Sec. 856(c)(5)(H), as amended by Act Sec. 1532(a)). For purposes of determining REIT income, if the cutting is done by a TRS, the cut timber is deemed sold on the first day of the tax year to the taxable REIT subsidiary, with subsequent gain, if any, attributable to the taxable REIT subsidiary (Code Sec. 856(c)(5)(H)(ii)). These changes are effective for dispositions in tax years beginning after the enactment date, but won't apply for dispositions after the termination date. The termination date is the last day of the taxpayer's first tax year beginning after the enactment date and before the date that is one year after the enactment date.
Rules for new timber REITs --For tax years beginning after the enactment date, the Act creates new rules for a new entity called the timber REIT, defined as a REIT in which more than 50% of the value of its total assets consists of real property held in connection with the trade or business of producing timber. The Act says that: "... Mineral royalty income from real property owned by a timber REIT and held, or once held, in connection with the trade or business of producing timber by the REIT, is included as qualifying real estate income for purposes of the REIT income tests. This applies for royalty income earned in the first tax year beginning after the enactment date. (Code Sec. 856(c)(2)(I) and Code Sec. 856(c)(5)(I), as amended by Act § 15313)" Also, "... For tax years beginning after the enactment date, for a quarter that closes on or before the termination date (see above), a timber REIT may hold TRS securities with a value up to 25% of the value of the total assets of the REIT. (Code Sec. 856(c)(4)(B)(ii), as amended by Act § 15314)
REITs Holding Timber Not Penalized for Sales of Conservation Easements
For sales to qualified organizations for conservation purposes under Code Sec. 170(h), the Act reduces from four to two years the holding period required to be covered by the safe harbor provisions discussed immediately above. The Act also removes the safe-harbor requirement that marketing of the property must be done by an independent contractor, and permits a taxable REIT subsidiary of the REIT to perform the marketing. The Act also specifically provides that any gain that is eligible for the timber property safe harbor won't be treated as income from the sale of stock in trade, inventory, or property held by the REIT primarily for sale to customers in the ordinary course of the REITs trade or business. These rules are effective for dispositions in tax years beginning after the enactment date but don't apply for sales after the termination date, as defined under the first REIT change, above. (Code Sec. 857(b)(6)(G), Code Sec. 857(b)(6)(D)(v), and Code Sec. 857(b)(6)(H) , as amended by Act § 15315)
Retired and Disabled Farmers Excluded from SECA Tax on Conservation Reserve Rental Payments
The Self-Employment Contributions Act (SECA) tax applies to an individual's net earnings from self-employment up to the Social Security wage base, $102,000 for 2008. Net earnings from self-employment generally don't include rent from real estate and from personal property leased with the real estate. Conservation Reserve Program (CRP) pays annual rent to enrolled land owners and operators. The IRS originally treated CRP payments as rental income for those not otherwise engaged in farming, and therefore not subject to SECA. However, in Notice 2006-108, 2006-51 IRB 1118 the IRS issued a proposed ruling that would treat almost all CRP payments as self-employment income. The Act provides that CRP payments made after 2007 are not treated as self-employment income for SECA tax purposes if received by an individual who is getting Social Security retirement or disability payments (Code Sec. 1402(a)(1), as amended by Act Sec. 15301).
Tax Treatment of Donations of Conservation Easements Extended for Two-Year
In general, a deduction is permitted for charitable contributions, subject to certain limitations that depend on the type of taxpayer, the property contributed, and the donee organization. The amount of deduction generally equals the FMV of the contributed property on the date of the contribution. Charitable deductions are provided for income, estate, and gift tax purposes. Under the partial interest rule, a charitable deduction usually is not allowed if the donor transfers an interest in property to a charity while also either retaining an interest in that property or transferring an interest in that property to a noncharity for less than full and adequate consideration. Qualified conservation contributions are not subject to the partial interest rule.
The Pension Protection Act of 2006 (PPA) provided that for contributions made in tax years beginning in 2006 and 2007 the usual 30% contribution base limitation on contributions of capital gain property by individuals did not apply to qualified conservation contributions. Instead, individuals could deduct the FMV of any qualified conservation contribution to a qualified organization to the extent of the excess of 50% of the contribution base over the amount of all other allowable charitable contributions. In addition, individuals could carry over any qualified conservation contributions that exceed the 50% limitation for up to 15 years. In addition, a qualified farmer or rancher could deduct a qualified conservation contribution of up to 100% of the excess of the taxpayer's contribution base over the amount of all other allowable charitable contributions.
The Act extends these PPA provisions to contributions made before January 1, 2010. (Code Secs. 170(b)(1)(E)(vi) and 170(b)(2)(B)(iii), as amended by Act Sec. 15302).
New Deduction for Endangered Species Recovery Expenses
Under current law (Code Sec. 175) a taxpayer in a farming business may elect to deduct instead of capitalizing to a land account qualified soil and water conservation expenses for the prevention of erosion to land used in farming. The deduction is limited to 25% of gross income derived from farming during the tax year. Any excess is carried forward to succeeding tax years subject to the 25% of gross income cap in those years. Note, however, that income from the production of timber is not income from farming for purposes of the Sec. 175 deduction (Reg. Sec. 1.175-3).
The Act provides that expenses paid or incurred after 2008 by farmers to achieve site-specific management actions under the Endangered Species Act of 1973 are soil and water conservation expenses for purposes of Sec. 175, subject to the 25% of gross farming income limitation. (Code Sec. 175(c)(1) , as amended by Act Sec. 15303)
Authorization for Qualified Forestry Conservation Bonds
The Act authorizes tax-credit bonds for acquisition of forest land, so-called qualified forest conservation bonds (QFCB's). These are bonds issued by state or local units of government, or 501(c)(3) organizations. Instead of the issuer paying interest on the bonds, the bond holders take a quarterly tax credit. The bonds are repaid with a balloon payment from a sinking fund build up over the bond period. The issuer is required to make annual payments to the sinking fund.
The bond funds must be used for the acquisition of qualified forests and forest land, defined as: (1) land, some portion of which is adjacent to U.S. Forest Service land; (2) at least half the land acquired must be transferred to the U.S. Forest Service at no cost, and no more than half the land may either remain with or be donated to a state; (3) all the land must be subject to a habitat conservation plan for native fish approved by the U.S. Fish and Wildlife Service; and (4) the amount of acreage acquired must be at least 40,000 acres.
The IRS is responsible for allocating a $500 million national limitation on bonds under the program over a 24-month period. IRS must start the solicitation of applications for a portion of the $500 million limit no later than 90 days after the enactment date (Code Sec. 54B , as added by Act Sec. 15316).
An issuer may, in lieu of issuing bonds, elect to treat their allocation as a deemed payment of tax (regardless of whether the issuer is subject to the income tax) that is equal to 50% of the amount of the allocation. This election is not valid unless the issuer certifies to the IRS that any payment of tax refunded to the issuer will be used exclusively for a qualified forestry conservation purpose. Such a deemed tax payment can't be used as an offset or credit against any other tax and doesn't accrue interest (Code Sec. 54A , as added by Act Sec. 15316).
Credit for Production of Cellulosic Biofuel.
For fuel produced after Dec. 31, 2008, the Act adds a "cellulosic biofuel producer credit" to the existing alcohol fuel credit (Code Sec. 40). This credit is a nonrefundable income tax credit for each gallon of qualified cellulosic fuel production for the tax year. The amount of the credit is $1.01 per gallon, however, in the case of cellulosic biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for such alcohol under the alcohol mixture credit as in effect at the time cellulosic biofuel is produced and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small ethanol producers as in effect at the time the cellulosic biofuel fuel is produced. The credit terminates on Dec. 31, 2012. (Code Sec. 40(b)(6) , as amended by Act § 15321(b)) Also, the Act modifies the small ethanol producer credit so that it may be claimed for cellulosic ethanol in excess of 15 million gallons. (Code Sec. 40(b)(4)(C), as amended by Act § 15321(e)). Cellulosic biofuel and alcohol cannot qualify as biodiesel, renewable diesel, or alternative fuel for purposes of the credit and payment provisions relating to those fuels. (Code Sec. 40A(d) and Code Sec. 40A(f), as amended by Act § 15321(f)).
Limitation on Deduction of Farm Losses
The Act limits the deduction of certain farm business that receive designated subsidies. Although not directly applicable to timber production, this provision has not been reported by the press. Under current law taxpayers who materially participate in a farming activity can deduct in full net farming losses against other income from both passive and nonpassive sources. For taxpayers who don't materially participate in a farming activity, the passive activity rules limit the offset to income from nonpassive sources. For this purpose the trade or business of farming includes the trade or business of operating a nursery or sod farm, or the raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees (excluding evergreen trees that are more than six years old at the time severed from the roots, that is, Christmas tree).
For tax years beginning after 2009, the Act limits the farming loss of a taxpayer, other than a C corporation, for any tax year in which any applicable subsidies are received. The losses are limited to the greater of (a) $300,000 ($150,000 for a married person filing separately), or (b) the taxpayer's total net farm income for the prior five tax years. Applicable subsidies are (1) any direct or counter-cyclical payments under title I of the Food, Conservation, and Energy Act of 2008 (or any payment elected in lieu of any such payment), or (2) any Commodity Credit Corporation (CCC) loan.
Total net farm income is an aggregation of all income and loss from farming businesses for the prior five tax years. Any loss that is disallowed under the new rule in a particular year is carried forward to the next tax year and treated as a deduction attributable to farming businesses in that year. Farming losses arising because of fire, storm, or other casualty, or by reason of disease or drought, are disregarded for purposes of calculating the limitation. (Code Sec. 461(j), as amended by Act § 15351).