Federal Income Taxes: Four Essential "To Do's" for Forest Landowners

Did you know you can deduct original purchase costs and timber sale-related expenses from timber sale proceeds? Did you know that reporting your timber as a capital gain can reduce your tax rate by as much as 20%? Did you know you may be eligible for deducting up to $10,000 per year of expenses related to stand establishment (i.e., regeneration)? In Pennsylvania, regeneration includes costs of fencing, herbicides, and, of course, tree planting. These, among others, are tax incentives offered by the IRS specifically for timber growers in the US. Over the last 20–30 years, Congress has passed laws to encourage timber production and tree establishment. More information about these and other tax incentives is found at the end of this article. Before moving forward, consider these four important points to get you on your way:

1. Have a profit motive to take advantage of tax incentives. The government's timber tax incentives are in place to stimulate forest investment and production of wood and fiber (we are not yet there for tax incentives for environmental services from forests, such as carbon, clean air, etc). Timber investment and production imply a profit, and the IRS wants to see your profit motive. However, a profit motive doesn't mean you have to cut timber often, but in your management plan, you need to demonstrate that at some point in the future, you intend to sell timber and hopefully make a profit. For the IRS, the profit you are showing from growing timber is the appreciation in the value of the timber, i.e., its physical growth and quality are enhanced over time. We know in Pennsylvania that it takes decades for timber to mature, and so having a timber sale perhaps only once in your lifetime is standard practice.
2. Have a well-written forest management plan. Not only is this the most important document every forest landowner should have, it is also the first item an IRS auditor will look for. A management plan can put to rest many tax-related problems. Management plans come in many shapes and sizes, from detailed stewardship plans to simpler tree farm plans. (Note: there may be government cost-share monies available for writing your management plan, which may be excludable from income taxes). All plans should address your forest conditions, management objectives, and future activities. From the IRS perspective, the type of plan does not matter as long as the profit motive is well expressed. This implies showing growth, yield, and harvest schedules.
3. Keep accurate and complete records. Time spent on recordkeeping is time well spent. If you only occasionally have forest management activity (i.e., forest management expenses incurred or income received), a shoe box method works fine. More active owners may want to keep something more detailed and formal. You should become familiar with Form T, the basic timber recordkeeping Form provided by the IRS. Keep records of everything related to your forest management. Receipts from registration, mileage, and meals attending your local woodland owner's workshop and consultant fees are typical expenses that can be deducted annually from your income taxes. Remember to separate personal expenses from forest management ones.
4. Finally, tying these all together, create a professional tax team. Maximizing the tax advantages offered by the IRS requires a variety of expertise. A landowner need not be a tax expert to but needs to ask the right questions. First is a professional forester who deals with forestry-specific issues such as quantifying timber volume and value. This information is used, for example, in determining allowable deductions from timber sales revenues. Next are financial advisors, which may include an accountant, bookkeeper, tax preparer, banker, or a combination thereof. One of the financial advisor's main goals is to help you minimize your tax burden. An attorney is another member of the team. Attorneys are critical when it comes to decisions about business entities (sole proprietorship, partnerships, trusts, etc), and estate planning (gifting or bequesting assets). The key to successful forest management is having these members of the team understand your goals and objectives and work together. Where can one find a knowledgeable professional? Penn State Extension keeps a list of over 300 people who have taken our one-day intensive tax seminar. Don't forget, your family is also a part of the team and the decision-making process.

Tax laws and the IRS Code are not only confusing but change constantly. Keeping up to date requires diligence that includes working with your tax team and understanding the issues. Short courses for forest landowners on tax issues are available from Penn State Extension, such as "Timber Taxation". Also, suggested readings range from a very simple two-pager annually distributed by the USDA Forest Service called "Tax Tips," to the detailed USDA Forest Service "Forest Landowners' Guide to the Federal Income Tax" (PDF).

Prepared by Michael Jacobson, associate professor of Forest Resources