Section 610, General
Internal Revenue Manual
Specialized Industry Guidelines - Timber
Section 610, General
Last amended: 6-26-1978
General
(1) IRC 611, which applies specifically to natural resources, states that, in computing taxable income in the case of timber, there shall be allowed as a deduction a reasonable allowance for depletion and for depreciation of improvements. In the case of standing timber, the depletion allowance is computed on the adjusted basis of the property. Percentage depletion does not apply to timber. The deduction is allowed to provide for the tax-free recovery of the capital investment in the timber as the timber is cut, on the theory that it is compensation for capital consumed in the production of income through severance.
(2) The deduction from income for depletion of timber is allowed to the owner of an economic interest in standing timber, except an owner who has disposed of his/her timber with a retained economic interest under IRC 631(b). Under IRC 631(b) the owner, in computing gain or loss on the disposal of the timber, recovers his/her capital by deducting the basis of the timber from the amount received.
(3) The depletion of timber actually takes place when the timber is cut. The amount of depletion allowable with respect to the cut timber may be computed for accounting purposes when the quantity of timber is first accurately measured. However, the deduction for depletion is made effective in the taxable year in which the cut timber is sold. Since the inventory of logs or other products, not sold during the taxable year, is taken upon the depletion basis, (fair market value if IRC 631(a) has been elected), so much of the depletion allowance as is represented by logs in inventory is, in effect, denied as a deduction in that year. It becomes a part of the cost of goods sold in the subsequent year, thereby allowing the deduction for depletion in the year in which the products from the timber are sold rather than in the year in which the timber is cut.
(4) The amount allowable as a deduction for depletion is based upon what is called the depletion unit, or the unit depletion rate. Each timber account has its own depletion unit for any given taxable year. The depletion unit changes as adjustments are made to the timber account. The method of determining the depletion unit is prescribed by regulations and is illustrated in Schedule F of Form T.
(5) The depletion unit applicable to the timber in a given timber account during any taxable year is determined by dividing (a) the sum of the adjusted basis at the beginning of the taxable year plus the cost of the number of units of timber acquired during the year plus other proper additions to capital during the year, by (b) the number of units of timber in the account at the beginning of the year plus the number of units acquired during the year plus (or minus) the number of units required to be added (or adjusted) by way of adjustment. The number of units of timber cut during the year multiplied by the depletion unit applicable to the timber in that account determines the amount of depletion allowable for that timber. This depletion unit is also applicable to timber sold and to timber lost through fire, trespass, or other casualty for purposes of determining gain or loss.
(6) The Depletion Allowance (DA) for each timber account for each taxable year may be computed by using the following simplified formula: The Depletion Allowance is equal to the adjusted basis divided by the total number of timber units, multiplied by the total number of timber units cut.
(7) Any of the three factors needed to compute depletion: adjusted basis; total number of units; and number of units cut during the year, may have been erroneously reported by the taxpayer causing a distortion of taxable income. The examiner will need to verify the correctness of each.