• Home
• Federal Income Taxes
  • Timberland Acquisition
  • Structuring Ownership
  • Timberland Appraisal
  • Determine Your Basis
  • Record Keeping
  • Management & Operating Expenses
  • Reforestation Expenses
  • Cost-Share Payments
  • Depreciation
  • Casualty Losses
  • Timber Sales & Income
  • Conservation Easements
  • Christmas Trees
  • Exchanges
  • Form T
  • Electronic Filing
• State Tax Laws
• Estate Planning
• Publications
• Professional Research
• Tax Workshops/Education
• Tax Policy
• Links

Section 1221 - Definition of a Capital Asset

Historically a distinction has been made between the taxation of capital gains and ordinary income. The taxation of capital gains has been given preferential treatment. The creation of this capital gain preference reflects a fundamental decision by Congress that not all income from dealings in property has the same characteristics. In order to receive this preferential treatment, a taxpayer must sell or exchange a "capital asset."

The value of property often changes over time with any increase or decrease in value taken into account or "realized" in the year the property is sold or exchanged for other property. If the property is a capital asset special rules apply. Where the property is not a capital asset and sold at a gain, the gain will generally be taxed at the same rate as ordinary income, no matter how long the property was held.

Where the sale of a capital asset results in a loss, the amount of loss that may be deducted is subject to limitations. Generally for individuals, capital losses may be used to offset capital gains and up to $3,000 of ordinary income. In addition, unused capital losses for a tax year may be carried over by individuals to future years.

The capital gain and loss provisions, however, do not tax gains which are not otherwise taxable under the Code, nor do they allow losses not otherwise deductible.

There are two principal requirements in order for the capital gain and loss provisions to be applicable:

1. There must be either a capital asset, or property which under Section 1231 is treated like a capital asset, and
2. There must be a sale or exchange.

The term "capital assets" includes all classes of property not specifically excluded by Section 1221. In determining whether property is a capital asset, the period for which held is immaterial.

Capital Asset defined - Section 1221 of the Code defines what a "capital asset" is by listing the types of property excluded from capital asset treatment:

Capital assets include all property, regardless of how long held, with the following exceptions -

1. inventoriable stock in trade and property held "primarily" for sale to customers in the ordinary course of a trade or business
2. depreciable business property and real estate used in a trade or business;
3. a copyright, a literary, music, or artistic composition, or similar property held by a taxpayer whose efforts created such property or in whose hands the property has the same basis as it had in the hands of the person whose personal efforts created it;
4. accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of inventoriable assets or property held for sale in the ordinary course of business;
5. short-term non-interest-bearing government obligations (state or Federal) issued on or after March 1, 1941 and acquired before June 24, 1981, on a discount basis;
6. U.S. Government publication (including the Congressional Record) which are received by: (1) a taxpayer from the government without charge or below the price at which they are sold to the general public or (2) a second taxpayer who receives the publications from the first taxpayer described in (1) and who determines his basis in the publication by reference, in whole or in part, to the basis of the publication in the hands of the first taxpayer;
7. other miscellaneous classes of property.

Affects on timberland - Timber is a capital asset in your hands if it is not considered to be property held for use in a trade or business of yours, and is not held "primarily" for sale to customers in the ordinary course of a trade or business or yours.

The Supreme Court held that the word "primarily", as used in the definition of capital asset, means "principally" or of "first importance". Support for this interpretation, according to the court, was the fact that the legislative purpose for this provision was to differentiate between ordinary profits arising in the everyday operation of a business and the realization of appreciation in value of an asset accrued over a substantial period of time.

Among the test indicated by the courts for determining whether property is held primarily for sale are the following:

1. The frequency of sales of property as opposed to isolated sales or transactions,
2. The activity of the seller or those acting under his instructions or in his behalf, such as making improvements to the property and advertising it to attract purchasers,
3. The nature and extent of the taxpayers business,
4. The purpose for which the property was originally acquired, and
5. The purpose for which the property was held during the period in question.