Family Forestland Ownership as a Business

Presented by

Mike Reichenbach

Regional Extension Educator

University of Minnesota

10/2008

Items to be covered

• Operation as a business

– Advantages

– Documentation

• Your management plan

• Your forest journal

• Timber sales -- income and expenses

• Forest hobby

Participants will be able to

• Make a decision regarding operation as a business, investment or hobby

• Provide their tax preparer with information about income taxes for family forest landowners

• • Explain why returns and costs of forest mgmt

should be in the forest mgmt plan

• Will be able to use a forest journal

Do you have a forest management plan?

Yes

Yes

, it h

as n

ot b

een

...

No, I

ow

n >

20 a

cres

..

No, I

ow

n <

20 a

cres

..

0% 0%0%0%

10

1. Yes

2. Yes, it has not been updated > 10 years

3. No, I own > 20 acres of forest

4. No, I own < 20 acres of forest

Do you keep a journal of activities and actions that you carry out on

your forestland?

0%0%0%

Yes No I do not own fore...

1. Yes

2. No

3. I do not own forestland

10

Exercise and discussion

Page 1 of the Forestland Journal

Do you operate your forestland as a

Busi

ness

Inve

stm

ent

Hobby

I do n

ot ow

n fo

rest

land

I am

not

sure

0% 0% 0%0%0%

10

Pick the number that best describes the operation of your forestland.

1. Business2. Investment3. Hobby4. I do not own

forestland5. I am not sure

Types of business income

• Active -- owner(s) take actions to protect and enhance the value of the asset and meet one of several -- material participation or time involvement tests

• Passive -- owner(s) take actions to protect and enhance the value of the asset but do not meet any of the time involvement tests

• Investment -- owners(s) expect appreciation in value and treat the land as they might a bond

Is it a business?

Profit three out of five years

IRS presumes you are a business

otherwise

Proof is up to the taxpayer

Can you operate as a business if you do not plan to harvest timber?

Yes N

o

0%0%10

1. Yes

2. No

Is it a business?

1. Manner in which the activity is conducted

2. Expertise in the activity

3. Time and effort required

4. Expectations of appreciation in value

Is it a business cont.

5. Previous success in similar activities

6. History of income or losses

7. Amount of profits or expected profits

8. Financial status

9. Elements of personal pleasure

How might you show you are in business?

• Developing a timber management plan

• Belonging to a forestry association

• Enrolling in the Tree Farm Program

• Attending forestry classes

• Maintaining a forest journal

Forest income and expenses

Activity Investment Passive Active

Timber Sale/lump sum or pay as cut

Capital gain

Capital gain

Capital gain

Mgmt expenses

Misc. itemized deduction or capitalize

Deduct from passive income or capitalize

Deduct from any income

Why operate as a business?

• Capital gains treatment of income = lower tax rates ~ 15%

• Deduction of expenses from any income (active business only)

• No self-employment tax on capital gains

• No reduction of social security benefits (not considered earned income)

How would you like to operate your property?

Busi

ness

Inve

stm

ent

Hobby

I do n

ot ow

n fo

rest

land

I nee

d more

info

rmat

ion

I nee

d more

tim

e

I hav

e dec

ided

0% 0% 0% 0%0%0%0%

20

Pick up to two numbers that best describes your future intention.

1. Business2. Investment3. Hobby

4. I do not own forestland5. I need more information6. I need more time7. I have decided

Exercise and discussion

Page 2 of the Forestland Journal

Timber sales; expenses

• Operating expenses

• Capital expenses

– Depreciation– Section 179 Election– Amortization– Depletion allowance

Section 179 Election

• Deduct all or part of the cost of personal property the year it is placed in service

• Elect in the year property first placed in service• Limits

– Maximum annual limit is $250,000 (increased for one yr from 125K

– $250,000 deduction is reduced $1 for each $1 of personal property investment over $800,000

– Deductions are limited to the amount of taxable income from active conduct of a any of your businesses, carry forward excess

Report: Form 4562Information: IRS Publication 946

Amortization and tree planting

• After October 21, 2004 < $10,000 of reforestation expenses maybe deducted

• > than $10,000 of expenses are amortized over 8 years.

Timber sales and depletion

Deduct from income

• Timber sale expenses • Depletion allowance

Sale expenses include:

– Advertising– Timber cruise– Marking– Scaling– Consulting fees

Timber sales and depletion

• Depletion allowance = (total basis/total volume before the sale) x number of units sold

• Original cost (basis) recorded in an account

• Adjustments to original cost (basis)

– New expenses will increase the basis

– Timber sales will reduce the basis

Example: depletion allowanceMerchantable Timber Account

Date Description Amount $ Basis9/01 timber purchase 2000 cords $40,78010/07 current volume 2,695 cords $40,78011/07 timber sale (1,000) cords ($15,130)11/07 net 1,695 cords $25,650

Depletion Unit:$40,780 ÷ 2,695 cords = $15.13/cord

Depletion Allowance:1,000 cords sold x $15.13/cord = $15,130

Example: timber sale

18,000 Timber sale income

(1,800) Consulting forester

( 70) Advertising

(15,130) Depletion allowance

1,000 Net income

Report $1,000 of capital gain on Form 4797, Part I

Other woodland income

Report as ordinary income:

• Products derived from treeslumber fuelwoodpulpwood chipspoles fence posts

• Maple syrup• Fruit, Nuts, Bark• Nursery stock• Tree limbs and tops left after logging• SFIA payments

If you are not in business,how are costs recovered?

Hobby

• Property taxes may be deducted

• Timber sale expenses may be deducted as an itemized deduction and reduce your taxes only if the expenses exceed 2% of your gross income

• Timber sale income is ordinary income

• You are subject to self-employment taxes

One forester’s view

Consult with your

– Tax preparer

– Accountant

– Legal advisor

Sources of information

Forest Landowners’ Guide to the Federal Income Tax: www.fs.fed.us/spf/coop/

National Timber Tax Website: www.timbertax.org

Mel Baughman, (612) 625-1288, baughman@umn.edu

Mike Reichenbach, (218) 726-6470, reich027@umn.edu

Geary Searfoss CPA, (715) 266-8290