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Family Forestland Ownership as a Business
Presented by
Mike Reichenbach
Regional Extension Educator
University of Minnesota
10/2008
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Items to be covered
• Operation as a business
– Advantages
– Documentation
• Your management plan
• Your forest journal
• Timber sales -- income and expenses
• Forest hobby
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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
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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
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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
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Exercise and discussion
Page 1 of the Forestland Journal
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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
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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
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Is it a business?
Profit three out of five years
IRS presumes you are a business
otherwise
Proof is up to the taxpayer
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Can you operate as a business if you do not plan to harvest timber?
Yes N
o
0%0%10
1. Yes
2. No
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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
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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
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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
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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
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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)
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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
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Exercise and discussion
Page 2 of the Forestland Journal
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Timber sales; expenses
• Operating expenses
• Capital expenses
– Depreciation– Section 179 Election– Amortization– Depletion allowance
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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
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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.
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Timber sales and depletion
Deduct from income
• Timber sale expenses • Depletion allowance
Sale expenses include:
– Advertising– Timber cruise– Marking– Scaling– Consulting fees
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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
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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
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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
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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
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If you are not in business,how are costs recovered?
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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
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One forester’s view
Consult with your
– Tax preparer
– Accountant
– Legal advisor
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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, [email protected]
Mike Reichenbach, (218) 726-6470, [email protected]
Geary Searfoss CPA, (715) 266-8290