Catching Up On a Recent Tax Development
Tree Farmer Magazine: May/June 2006 - Volume 25 No. 3
In my 30-plus years of timber tax work I can't remember another period with so many changes to the law and is administration. In the last issue I focused on the changes impacting Tree Farmers hit by last year's string of hurricanes. This column picks up there and updates you on changes affecting all Tree Farmers. Unfortunately, most of my comments have to do with topics for which definitive answers aren't available. I hope you're used to this by now.
Carryback of Net Operating Loss Extended to Five Years
If you have a tree farm in one of the Gulf Opportunity Zones (GOZ), be certain that your tax preparer takes advantage of this provision if you have a net operating loss (NOL). A NOL occurs when your losses exceed your income. The Gulf Opportunity Zone Act (GOZA) provides taxpayers with NOLs resulting from losses to timber property in a GOZ can carry the NOL back five years instead of the normal two years. As before, if the NOL is not offset by filing amended returns for the previous five years, it is carried forward for up to 20 years. This provision simply provides - to owners of qualified timber property - the treatment applicable to farming under Internal Revenue Code Sec. 172. As with the increase in the reforestation deduction, the extended carryback provision does not apply to corporations with publicly traded stock, real estate investment trusts, and owners or lessees of more than 500 acres of timberland.
Revised Form T Released
A revised Form T - Forest Activities Schedule has been released by the IRS. The form itself and the instructions are now separate documents. The instructions clarify that only taxpayers who make more than one or two timber sales every three to four years need to file Form T. But even if you don;t have to file Form T, the IRS wants you to complete the appropriate part of the form when you have timber transactions and keep the filled-out form in your files for as long as you own the land and/or timber.
A major accounting change reflected on the form is the need to track separately each reforestation project. This change results from the impact of the reforestation deduction and amortization provisions on depletion accounts. Stands of timber resulting from reforestation projects for which the expenses have been deducted and/or amortized will most likely have a zero basis - and this must be discernible in your records. Changes to how casualty losses are treated and reforestation expenses recovered make if increasingly important that your depletion accounts be set up and maintained appropriately. I'll discuss this in mores detail when guidelines are finished.
Domestic Production Activities Deduction
In the January/February 2006 issue I discussed the application of the so-called domestic production activities deduction, Sec. 199, to timber owners and processors. Eventually, this provision will provide a deduction or adjustment to gross income equal to the smaller of 9 percent of qualified income or 50 percent of W-2 wages. Proposed regulations for Sec. 199 specify that the deduction is not applicable to taxpayers if an election to treat a cutting as a sale under Sec. 631(a) of the tax code is in effect. An effort is under way by the American Forest & Paper Association to change this through legislation.
Perhaps the biggest unanswered question regarding the application of Sec. 199 to timber transactions is how it applies to disposals of timber under a contract-right-to-cut, presented as Example 5 in the January/February column. The IRS has not taken a position on this issue, but has it under consideration.
If you are going to use Sec. 199, please be certain that your tax preparer is familiar with property law in your state and determines your tax treatment with the understanding that the deduction only applies to income generated from the sale of tangible personal property, not real property. In some states it's common practice to write contracts reflecting applicable state law regarding when timber goes from being real property to personal property. This is usually motivated by state tax provisions. I'll let you know here and on the National Timber Tax Website (www.timbertax.org) as soon as guidance is provided.
Casualty Loss Deduction Due in Part to Lower Market Value
Hurricanes in the Gulf area have resulted in significantly lower stumpage prices for merchantable timber remaining afterwards. This can lead to a casualty loss deduction due, in part, to the decline in the value of the remaining stand, not just to the loss due to timber destroyed.
Recall that a casualty loss is now determined for the entire block, not each unit of timber destroyed. A block is usually all the timber in one depletion account. If the block includes timber that wasn't destroyed then the required valuation of all the timber in the block before the casualty and after the casualty will result in an after valuation that's lower, due to the decline in market price applied to the remaining timber.
Even though the resulting loss determined this way may be greater than would have been acceptable under the procedure based on individual units of timber destroyed, the so-called additive approach, a tax determination based on procedures published by the IRS, is valid. Of course, the estimates of before-and-after fair market values, factual determinations, can be questioned. This is another reason to use a professional tax preparer and experienced consulting forester to do the appraisals.
Multiple Qualified Timber Properties
The annual $10,000 reforestation deduction is available for each qualified timber property (QTP) you own or lease. The cap is $5,000 each for married filing separately. In GOZs the $10,000 limit is increased to $20,000 for qualified expenditures from August 29 2005, until December 31, 2007, discussed in the last issue.
The definition of QTP remains ambiguous, but a series of examples demonstrating possible definitions has been added to the National Timber Tax Website (www.timbertax.org). The most favorable definition for Tree Farmers would be that each reforestation project is a separate QTP, subject to the annual limit. The least favorable would the guideline suggested in the last issue. This was that all reforestation expenditures made for projects on land included in a given block as defined in your depletion accounts constitutes a QTP.
Consult with your tax professional to determine hoe aggressive you should be on this issue.