To run a woodlot business, it takes much more than chopping, loading and delivery. There comes a time when you need to shuffle some papers and crunch some numbers. As with any business, tax time can be a bit stressful. For the woodlot owner, managing taxes can be even more stressful due to lack of understanding about the process.
Kellie Hanas, a certified public accountant and senior manager at Hill, Barth & King (HBK), a Meadville, Pennsylvania-based company that specializes in timber tax, noted that many farmers who have property and timber aren’t versed in the ins-and-outs of timber tax.
“There are a lot of busy, hardworking people actively farming or working full-time off the farm,” she said. “Whether you’re a (timber) investor or a business, you absolutely want to get the proper advice from someone experienced with timber tax law.”
When filing timber tax for woodlot owners, one thing is certain: There’s plenty of help around.
For instance, Hanas’ focus is Pennsylvania where other specialists like Mike Jacobson, a professor of Forest Resources at Penn State, run nominal-cost or free workshops for private landowners to raise awareness of timber tax and any relevant changes. Dr. Linda Wang, a national timber tax specialist for the U.S. Forest Service, recently offered a free webinar to help woodland owners, foresters and their tax advisors prepare for filing 2014 federal tax returns.
When preparing for tax time, understand there are three basic types of timber ownerships: investment, business or personal use property. For each year, you must determine use. You should document profit motive in your forest management plan.
When Hanas first meets with a new timber farmer, she asks about the plans for the property or business, to determine whether the client views it as a purchase to invest in and to have a return on or as a property that was purchased to build a home on.
“Many that I work with treat it as business, have consulting foresters and have a management plan,” she said. “You absolutely need a management plan. It’s what the IRS would look at. Do you have a separate business checking account? Do you track the number of hours spent? You can’t claim you’re a business without material participation, so do you spend 500 hours a year on property or 100, and is no one else working more hours out there than you? Are you doing reforestation, planting seedlings and doing what the management plan says? Are you keeping track of expenses?”
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Seeing the taxes before the trees
As a landowner, you may need to complete a Form T, or Forest Activities Schedule. Due to IRS changes, landowners need not file Form T every year if they’re only having an occasional timber sale. You still need to have information filed to document depletion, any expenses and basis utilized.
Because Form T is involved, woodlot owners should seek foresters to correlate basis – what you pay for what timber was there initially.
Say a woodlot owner bought the land (and trees) for $200,000, but there’s also value to buildings on the property. So the $200,000 is not typically broken down at the time of the sale. Based on a percentage of what you paid for everything, the landowner needs to know fair market value along with amount of board feet of the timber alone at purchase. This is the type of information to obtain from a certified professional forester.
You need an established price at time of purchase. If you’ve had the property a while and now want to begin generating income (and deducting expenses) most foresters can grow it back to required fair market value from a few years ago, but it’s more difficult after 10 years of growth, Hanas said.
Some sellers just sell raw land, and have no idea what the timber is worth on its own, so timber often comes at a bargain purchase. But you can’t then go back and say the timber is worth $150,000 if you only paid $100,000 for everything.
The bottom line is that you must establish a basis. A question of loss is a case in point. Say you have a windstorm and lose trees, and seek a deduction for the loss. You may say they’re worth $3,000, but you can’t take a deduction if there’s been no basis established.
Deductions for a woodlot owner can vary, but often reforestation costs are the largest, but they’re not every year. There’s also fertilizer used, management plan-consulting forester expenses, or perhaps a fence or temporary bridge was needed for a sale. There are travel expenses for a conference, or membership-association costs, and mortgage interest. Equipment costs are depreciated.
“It’s hard to know who is doing it appropriately and who is not,” Hanas said. “There are people who do not necessarily report any of the income. …they do not think it’s taxable because they do not receive a Form 1099 from the purchases. But our loggers and sawmills who buy direct from landowners provide a 1099S to the landowner. But a lot do not receive that form and do not report timber income.”
How do you change the culture? Hanas said it’s just raising awareness and communicating the rules.
For many who are treating their tree farm as a business, if they’re also general farmers, then they would include a Schedule F as a sole proprietor. For others who are sole proprietors and do not have other farm income, they would file Schedule C. There are hobby-loss rules, so a business can only have so many years of losses to offset profits before a challenge from IRS becomes likely, though the IRS recognizes that business-oriented tree farmers may not be able to show a profit every few years.
“It helps a bit in timber that the IRS recognizes that you still do have earning potential but it’s ‘still on stump,'” Hanas said. “The profit is there, but it’s still growing, which is different from raising beef cattle or dairy cows.”
(For more detailed explanations and examples, visit http://www.timbertax.org/developments/TaxTips2014.pdf).
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