Management and Operating Expenses
These are the ordinary and necessary costs associated with the day-to-day operation and management of business and investment property. These are not capital costs and are not associated with the disposal of an asset. Legitimate operating expenses can be written off against current income, even if the property is currently producing no income, provided that the activity is being engaged in for profit and the expenses are directly related to the income potential of the property.
The authority for deducting management and operating expenses is based on how you structure your timber activities:
The Internal Revenue Code clearly specifies that the activity must be carried out with the intention of making a profit and in recent years the courts have consistently ruled that there must also exist a reasonable expectation of eventually making a profit.
There are several factors that the IRS will consider in deciding if the intent to make a profit is present:
- Manner in which you carry out the activity (hobby or business like)
- Expertise and knowledge in carrying out the activity
- Amount of time devoted
- Assets appreciate
- Success of taxpayer in carrying out the activity
- Taxpayers history of income or losses
- Financial status of the taxpayer (how much of ones wealth is tied up in this activity)
- Elements of personal pleasure or recreation involved
It should be noted that it is a combination of these factors that the IRS will consider.
NOTE: If your timber activities involve the raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees (except as defined in IRC Sec. 631(a) and (b)) your timber activities may be subject to the "Uniform Capitalization Rules".
All the ordinary and necessary expenditures associated with growing timber held with the intention and reasonable expectation of producing income can be recovered in one of three basic ways:
Capitalize: Expenditure is entered into a capital account to be recovered over a period of years through depreciation, amortization, allowable basis, depletion, or by sale or other disposal of the property.
Expense: Deduct from gross income for the tax year in which the expenditure occurs, or carryover for recovery in a later tax year in the case of passive losses or a net operating loss.
Deduct from sale proceeds: Expenditures associated with a timber sale or other form of disposal are deducted from any proceeds received.
To be deductible the expenses must be ordinary and necessary for the proper management of the timber for timber production. Expenses not strictly necessary for the management of timber or other products or services for income are not eligible. Some expenses, known as "carrying charges," can be expensed or capitalized at the discretion of the taxpayer.