Revenue Ruling 71-354, 1971-2 CB 246
REV-RUL, Basis for allowance of cost depletion., Revenue Ruling 71-354,
1971-2 CB 246, (Jan. 01, 1971)
Section 612.--Basis for Cost Depletion
26 CFR 1.612-1: Basis for allowance of cost depletion.
(Also Sections 611, 631; 1.611-5, 1.631-1.)
Treatment of amounts expended by purchasers of timber for road construction on National Forest lands for which "Purchaser Credit" is earned under a Forest Service contract.
Advice has been requested concerning the treatment for Federal income tax purposes of amounts expended for construction of roads for which "Purchaser Credit" is earned by purchasers of timber under a form of timber sale contract used by the Forest Service, United States Department of Agriculture.
The form of contract in question is a "Forest Service Contract, Form 2400-5" and is commonly referred to as a "road credit contract." Sales of timber are conducted by the Forest Service by oral auction or sealed bids and the contracts are awarded to the highest eligible bidder. Duration of the contracts varies from two to five years or longer.
The contracts set forth the estimated quantities of included timber and provide that all timber shall be paid for as cut at stated contract rates. The contract rates are those bid by the purchaser and usually vary according to species. The total price bid takes into account the estimated cost of constructing, on National Forest lands, certain "specified roads" which the Forest Service considers necessary for use by the purchaser in harvesting the timber.
The purchaser is entitled to receive "Purchaser Credit" for constructing the specified roads in accordance with the specifications in the contract (called a "road credit" by the industry). The amount of credit that can be earned is also set forth in the contract.
The contract provides that charges for the timber cut will be made when the Forest Service furnishes to the purchaser periodic statements of the volume and the value of timber cut. Any "Purchaser Credit" earned is offset against the periodic statement amount and the balance is payable in cash.
Under unusual circumstances the purchaser may construct the specified roads and earn the "Purchaser Credit," even though the use of such roads for harvesting the timber is undesirable or unnecessary.
The example set forth below illustrates the manner in which the "Purchaser Credit" is offset against the amount payable for timber cut under a "Forest Service Contract, Form 2400-5."
A taxpayer, (X), was the successful bidder on a Forest Service offering of pine timber under a 2-year cutting contract estimated to include 2,000 M board feet log scale. The bid rate was $35 per M and the total price is estimated to be $70,000. X may earn "Purchaser Credit" in the amount of $20,000 by constructing specified roads in accordance with the contract. X built the specified roads at an actual cost of $18,000, earned the "Purchaser Credit," and cut all the timber subject to the contract. The total quantity of cut timber (logs) amounted to 1,900 M board feet by actual sale. The total amount payable by X to the Forest Service was the product of 1,900 times $35 or $66,500. This amount was offset by the $20,000 "Purchaser Credit" and X paid only the amount of $46,500 to the Forest Service.
Section 1.1012-1(a) of the Income Tax Regulations states in part:
In general, the basis of property is the cost thereof. The cost is the amount paid for such property in cash or other property.
Section 1.611-1(a)(1) of the regulations provides in part:
Section 611 provides that there shall be allowed as a deduction in computing taxable income in the case of mines, * * * and timber, a reasonable allowance for depletion. In the case of standing timber, the depletion allowance shall be computed solely upon the adjusted basis of the property.
Section 1.612-1(b)(1) of the regulations provides, in pertinent part, that the basis for cost depletion of mineral or timber property does not include amounts recoverable through depreciation deductions, through deferred expenses, and through deductions other than depletion.
Section 1.611-5(a) of the regulations states, in part, as follows:
"Section 611 provides in the case of * * * timber that there shall be allowed as a deduction a reasonable allowance for depreciation of improvements * * *. The deduction allowed under section 611 shall be determined under the provisions of section 167 and the regulations thereunder.
The cost of roads built by a taxpayer on the lands of another for the purpose of providing access to timber acquired under a cutting contract is normally recovered through depreciation deductions over the term of the cutting contract, or the expected useful life of the roads to the taxpayer. See situation 5 of Revenue Ruling 68-281 C.B. 1968-1, 22.
In the foregoing example, if the specified roads were necessary for the taxpayer's logging operation, their cost of $18,000 would be essentially a logging road expense, recoverable by the taxpayer over the term of the contract, and the "Purchaser Credit" of $20,000 would not be includable in the taxpayer's basis for cost depletion of the timber. Section 1.612-1(b)(1) of the regulations.
On the other hand, if the taxpayer does not use the specified roads in
its logging operation, their cost of $18,000 would not be recoverable
through depreciation deductions since the roads are not property used in the
taxpayer's trade or business or held for the production of income and thus
have no useful life to the taxpayer. Under such circumstances, the
actual cost of the roads, $18,000, but not the "Purchaser Credit,"
would become a part of the cost of the timber includible in the basis
for cost depletion.
Accordingly, it is held that the basis for cost depletion of timber cut by X under the "Forest Service Contract, Form 2400-5" is $46,500 and does not include the "Purchaser Credit" earned by X for the specified road construction.
It is further held that the $18,000 in the example expended by X for construction of the specified roads for which "Purchaser Credit" is earned is to be (1) treated as logging road costs recoverable through depreciation deductions if such roads are used by X for harvesting the timber included under the contract, or (2) added to X's basis for cost depletion of the timber cut if such roads are not used by X for harvesting the timber