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Letter Ruling 9822020, February 18, 1998

Uniform Issue List Information:
UIL No. 0631.02-00
Gain or loss in the case of timber, coal, or domestic iron ore
- Disposal of timber with a retained economic interest

Code Sec. 631

This letter is in response to a letter dated November 4, 1996, requesting a private letter ruling on behalf of the above taxpayer. Your request concerns whether Taxpayer's dispositions of certain timber will satisfy the requirements of section 631(b) of the Internal Revenue Code.

FACTS:

Taxpayer is a private foundation to which Contributors plan to contribute standing timber. Taxpayer represents that Contributors have held the contributed timber for more than one year. These contributions will be in the form of several individual donative timber deeds with a duration of X years, after which time any uncut timber will revert to the Contributors. Taxpayer will offer the timber for disposition in a competitive bidding process immediately following receipt of each donation under either Contract One or Contract Two.

This letter addresses only dispositions of timber under Contract Two. Under this contract, Taxpayer authorizes the buyer to cut and remove, and the buyer agrees to cut and remove, all designated merchantable timber in the contract area. The buyer must pay a bid deposit to Taxpayer which will be held by Taxpayer until the buyer has complied with all provisions of Contract Two. In addition, the buyer will supply Taxpayer with a performance bond and a payment bond. The buyer will pay Taxpayer twice monthly for all timber cut and removed in the previous half-month period, based on the unit prices for each species set out in Contract Two multiplied by the scaled volume of timber of that species cut and removed in that period. Title to the designated timber, including the risk of loss due to casualty, stays with the Taxpayer until the timber is severed and paid for by the buyer. The contract term is three years, with extensions of up to a year in certain circumstances.

Ruling Requested:

Taxpayer has requested a ruling that Taxpayer's dispositions of donated timber pursuant to the terms of Contract Two will satisfy the requirements of section 631(b) of the Code.

Law and Analysis:

Section 631(b) of the Code provides that in the case of the disposal of timber held for more than one year before such disposal, by the owner thereof under any form or type of contract by virtue of which such owner retains an economic interest in such timber, the difference between the amount realized from the disposal of such timber and the adjusted depletion basis thereof, shall be considered as though it were a gain or loss, as the case may be, on the sale of such timber. The date of disposal of such timber shall be deemed to be the date such timber is cut, but if payment is made to the owner under the contract before such timber is cut the owner may elect to treat the date of such payment as the date of disposal of such timber. For purposes of this subsection, the term "owner" means any person who owns an interest in such timber, including a sublessor and a holder of a contract to cut timber.

In order for there to be a disposal of timber under a contract for purposes of section 631(b) of the Code, the buyer must have a contractual obligation to cut specified timber. See, e.g., Rev. Rul. 77-229 , 1977-2 C.B. 210 (citing Ah Pah Redwood Co. v. Commissioner, 251 F.2d 163 (9th Cir. 1957)[58-1 USTC ¶9153 ]; Jantzer v. Commissioner, 284 F.2d 348 (9th Cir. 1960); Patterson v. Belcher, 302 F.2d 289 (5th Cir. 1962) [62-1 USTC ¶9426 ], opinion amended and reh. den., 305 F.2d 557, cert. denied, 371 U.S. 921 (1962)). Pursuant to Section 1 of Contract Two, the buyer agrees to cut, remove, and pay for all the designated merchantable timber, and Section 23 allows Taxpayer to pursue a claim for breach of contract upon the buyer's failure to perform its obligations. Therefore, a buyer under Contract Two has a contractual obligation to cut specified timber.

Section 1.631-2(a)(1) of the Income Tax Regulations provides that for the purpose of determining whether or not the timber disposed of was held for more than one year before the disposal the rules with respect to the holding period of property contained in section 1223 of the Code shall be applicable. Section 1223(2) provides that in determining the period for which the taxpayer has held property however acquired there shall be included the period for which the property was held by another person, if the property has, for the purpose of determining gain or loss from a sale or exchange, the same basis in whole or in part in the taxpayer's hands as it would have in the hands of that other person. Section 1015(a) provides generally that the basis of property acquired by gift is the same as it would be in the hands of the donor. Consequently, since Taxpayer's basis in the contributed timber is the same as the basis of the timber in the hands of Contributors, Taxpayer's holding period includes the period for which Contributors held the timber. Based upon Taxpayer's representation that Contributors' holding period exceeds one year, Taxpayer is treated as having held the timber for more than one year.

Section 1.631-2(e)(2) of the regulations provides that in order to be the owner of timber a taxpayer must have a right to cut timber for sale on its own account or for use in its trade or business. The donative timber deeds by which Contributors will convey timber to Taxpayer give Taxpayer these rights. Consequently, Taxpayer is the owner of the timber for purposes of section 631(b) of the Code.

Neither section 631(b) of the Code nor the regulations thereunder give guidance on what constitutes a retained economic interest. Section 1.611-1(b)(1) , however, provides that an economic interest is possessed when the taxpayer has acquired by investment any interest in standing timber and secures, by any form of legal relationship, income derived from the severance of the timber, to which the taxpayer must look for a return of capital. In other words, an owner retains an economic interest under a timber cutting contract if the amount of the payment for the timber depends solely on the actual quantity of timber cut. Accordingly, because title to the designated timber, including the risk of loss due to casualty, stays with Taxpayer until the timber is severed and paid for by the buyer, and because payments to Taxpayer are based on the volume of timber severed from the property as determined by scaling, taxpayer will be treated as having retained an economic interest in the timber for purposes of section 631(b) .

Accordingly, based upon the facts and representations set forth above, we conclude that Taxpayer's dispositions of donated timber pursuant to the terms of Contract Two will satisfy the requirements of section 631(b) of the Code.

Except as specifically set forth above, we express no opinion concerning the federal tax consequences of the above-described facts.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

Sincerely yours, Harold E. Burghart, Assistant to the Chief, Branch 6, Office of the Assistant Chief Counsel, (Passthroughs and Special Industries).