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Rev. Rul. 56-434, 1956-2 CB 334

REV-RUL, SECTION 631.--GAIN OR LOSS IN THE CASE OF TIMBER OR COAL, Rev. Rul. 56-434, 1956-2 CB 334, (Jan. 01, 1956)

SECTION 631.--GAIN OR LOSS IN THE CASE OF TIMBER OR COAL
Applicability of section 631(a) and (b) of the Internal Revenue Code of 1954 to income received by a timber owner from pulpwood cut by an independent contractor from (1) tops and limbs of sawtimber trees felled by the owner and (2) from standing trees.

Advice has been requested (1) concerning the proper tax treatment of income received by a taxpayer from pulpwood cut from the tops and limbs of sawtimber trees by an independent contractor under the circumstances set forth below, and (2) as to the determination of the fair market value of sawtimber and cut tree tops and limbs under the provisions of section 631(a) of the Internal Revenue Code of 1954.

The timber owner (taxpayer), who is in the business of manufacturing lumber, severed certain trees of sawlog size, owned by him for more than six months prior to the beginning of the taxable year in which cut, and converted the sawlogs to his business, leaving the tree tops and limbs lying in place as felled. Under a cutting contract with an independent pulpwood contractor, the latter was licensed to cut pulpwood at certain rates per cord from the tops and limbs of sawtimber trees lying upon the ground and also to cut certain designated standing trees for conversion into pulpwood. The owner claimed the benefits of section 631(b) for income from the cutting of standing trees by the contractor and, with respect to income received for pulpwood cut from the tops and limbs of the sawtimber trees, he claimed either section 631(b) benefits or, if denied, additional fair market value under section 631(a) upon the standing sawtimber trees, cut by him, to the extent of the income received from pulpwood produced from the tops and limbs.

Section 631(b) of the Code provides, in part, that if a taxpayer disposes of timber, owned by him and held for more than six months before disposal, under a contract whereby he retains an economic interest in the timber, such disposal shall in effect be considered a sale or exchange of timber. Any gain or loss realized would then be subject to the provisions of section 1231 providing for capital gains treatment in case the aggregate gains exceed the losses. It is held that section 631(b) benefits apply only with respect to the standing trees cut by the contractor and not to the pulpwood cut by the contractor from the tops and limbs of the trees felled by the taxpayer, since in the latter case there has not been a disposal of standing trees (timber).

Under the provisions of section 631(a) of the Code, a taxpayer, who has owned timber or has held a contract right to cut timber for more than six months prior to the beginning of the taxable year in which it is cut, may elect to treat his cutting of such timber as a sale or exchange thereof. Gain for this purpose is the excess of the fair market value of the timber over its adjusted basis. Fair market value is determined as of the first day of the taxable year in which the timber is cut. This fair market value is thereafter considered the taxpayer's cost of such cut timber for all purposes for which cost is a necessary factor, including the determination of gain or loss on any subsequent sale of the timber products. The gain or loss on such subsequent sale is treated as an ordinary gain or loss.

Ordinarily, fair market value of standing timber is determined upon the basis of current transactions in similar timber expressed in unit value per 1,000 board feet for sawtimber. In the usual transaction, all of the purchase price is allocated to the sawtimber content of the standing tree and nothing to the tops and limbs, which may be usable for pulpwood. When fair market value of timber cut under section 631(a) is determined by using the sawtimber unit value arrived at from such transactions in which all of the value has been allocated to the sawtimber, no additional value is allowable for the pulpwood in the tops and limbs. Therefore, in such cases, a taxpayer would not be entitled to increase the fair market value for purposes of section 631(a) with respect to any part of the amount he receives from a pulpwood contractor for pulpwood in the cut tops and limbs.

When the amount determined for the sawtimber content does not reflect the full fair market value of the tree and such tree value cannot be determined from comparative transactions, the additional fair market value of the tops and limbs in the standing tree can be determined by appraisal. In such appraisal, it is to be recognized that the selling price of the top and limbs on the ground represents principally a converted cost. Such cost is properly measured by an analysis which attributes to the top and limbs a fair share of all expenses incurred in felling and processing the tree, including road construction costs, to the stage where the top and limbs are available for the extraction and hauling of the pulpwood, plus a fair allowance for operating profit up to that point. Therefore, any additional fair market value assignable to the tree with respect to the top and limbs would be represented only by the excess of the proceeds from their sale over the amount determined by the above computation.

In view of the foregoing, it is held that section 631(b) benefits are applicable only to the disposal of standing trees (timber) held for more than six months before disposal, under a contract whereby the economic interest is retained, and that the section does not apply to income received from the sale of tree tops and limbs lying on the ground. It is further held that section 631(a) benefits are applicable to the entire standing tree cut by an owner or holder of a contract right to cut, since a tree top and the limbs are an integral part of the standing tree. However, the total fair market value of such tree, which must be determined for the purposes of section 631(a), is not represented by the sum of the fair market value of the standing tree for sawtimber and the amount received for the pulpwood after the tree was felled, but is merely the value of the standing tree. Therefore, the total amount received from the sale of the tops and limbs should be included in income as amounts received from the sale of goods.