Understanding timber sales and tax liability
While selling timber might be a once-in-a-lifetime event, you should understand how best to minimize the resulting tax liablity.
If you received money in 2012 for the sale of timber, that counts as income and is subject to taxation. The amount of tax you pay on that income will depend on the nature of the timber sale and how well you follow the procedure to minimize the tax liability.
Reporting your timber sales as ordinary income, like wages and salaries, will likely result in the largest tax burden. Failure to report any income comes with the risk of penalty.
To handle issues related to timber sales and taxes, the first step might be to visit the National Timber Tax website. This resource is kept current with the most recent changes in tax policy and provides access to forms and information. A visit with a professional tax preparer familiar with timber taxation is recommended by Michigan State University Extension. Not all tax preparers are familiar with this area of the tax code. A forest owner will likely also need the services of a consulting forester.
You’ll want to download Form T off the IRS website, which is not a form found at most local libraries.
The idea behind minimizing the tax bill is reducing the gross income to obtain a lower net income. There are three main ways to reduce the tax bill:
- Report income as capital gains
- Calculate the timber basis and depletion
- Keep receipts for all out-of-pocket expenses related to the timber sale
Check to learn if your timber sale income is eligible for capital gains tax rates, which are lower than ordinary income tax rates. Most timber sale income is eligible. You will need to have owned the timber for at least 12 months prior to the sale. Also, capital gains income does not have to pay self-employment taxes, which is nearly 15 percent.
Calculating basis and depletion values can be confusing. The basis is the monetary value of all your timber at the time it was purchased or acquired. The value is for only the timber and not the land where the timber is located. The depletion value is a portion of that basis and can be deducted from timber sale income based on the percentage of total wood volume harvested. So, if you harvest half your wood volume; then half the basis value can be deducted from the timber sale income. If the entire forest was harvested, then the entire basis value can be deducted from the timber sale income. Working with a professional forester can help identify timber volumes and values. This calculation is especially helpful if you have owned your timber for less than 10 years.
Deductions are fairly easy to subtract from the gross timber sale income provided you have receipts. Some expenses exist in a gray area of whether or not the expense was directly attributable to a timber sale. Expenses to hire a consulting forester, to set up and administer the timber sale, are clearly a deduction. Building a graded road is less certain. Determinations might be best made with the help of a tax preparer that knows about timber sale taxation.
For many forest owners, a timber sale is a once- or twice-in-a-lifetime event. The same is true for the resulting taxation. If you’ve had a timber sale in 2012, then take advantage of the IRS rules that minimize the tax bill. If you’re contemplating a timber sale in the near future, you might want to take a look at these IRS rules before the sale. Planning ahead can save you money.
Property taxation is a different topic. Michigan has two forest property taxation programs. They both require commitment to timber harvest and a professionally prepared forest management plan. Each program has eligibility criteria and each has withdrawal penalties. Become familiar with both programs before signing any agreements.
The Commercial Forest program has the largest tax breaks, but the forest becomes open to the public for hunting, fishing and trapping. Only foot access is required while vehicles are not. Access roads can be gated. The Qualified Forest Property (QFP) program has less of a tax break but the forest can be posted. The QFP may be revised at some point in 2013 but MSU Extension has a new bulletin that covers the current program. Therefore, forest owners may want to learn about the differences before making an enrollment decision.
Both of these programs are administered, at least in part, through the Michigan Department of Natural Resources. For those forest owners that live in a county served by a conservation district forester, more information can be obtained through them. You will also need to involve a consulting forester to help you develop a forest management plan. Of course, such a plan has many benefits and is a good idea regardless of your interest in property tax reductions.