Family Forestland Ownership as a Business

1. Family Forestland Ownership as a Business Presented by Mike Reichenbach Regional Extension Educator University of Minnesota 10/2008

2. Items to be covered • Operation as a business • Advantages • Documentation • Your management plan • Your forest journal • Timber sales -- income and expenses • Forest hobby

3. 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

4. 10 Do you have a forest management plan? • Yes • Yes, it has not been updated > 10 years • No, I own > 20 acres of forest • No, I own < 20 acres of forest

5. 10 Do you keep a journal of activities and actions that you carry out on your forestland? • Yes • No • I do not own forestland

6. Exercise and discussion Page 1 of the Forestland Journal

7. 10 Do you operate your forestland as a • Business • Investment • Hobby • I do not own forestland • I am not sure Pick the number that best describes the operation of your forestland.

8. 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

9. Is it a business? Profit three out of five years IRS presumes you are a business otherwise Proof is up to the taxpayer

10. 10 Can you operate as a business if you do not plan to harvest timber? • Yes • No

11. Is it a business? • Manner in which the activity is conducted • Expertise in the activity • Time and effort required • Expectations of appreciation in value

12. Is it a business cont. • Previous success in similar activities • History of income or losses • Amount of profits or expected profits • Financial status • Elements of personal pleasure

13. 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

14. Forest income and expenses

15. 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)

16. 20 How would you like to operate your property? • Business • Investment • Hobby • I do not own forestland • I need more information • I need more time • I have decided Pick up to two numbers that best describes your future intention.

17. Exercise and discussion Page 2 of the Forestland Journal

18. Timber sales; expenses • Operating expenses • Capital expenses • Depreciation • Section 179 Election • Amortization • Depletion allowance

19. 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 4562 Information: IRS Publication 946

20. 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.

21. Deduct from income Timber sale expenses Depletion allowance Sale expenses include: Advertising Timber cruise Marking Scaling Consulting fees Timber sales and depletion

22. 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

23. Example: depletion allowance Merchantable Timber Account Date Description Amount $ Basis 9/01 timber purchase 2000 cords $40,780 10/07 current volume 2,695 cords $40,780 11/07 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

24. 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

25. Other woodland income Report as ordinary income: • Products derived from trees lumber fuelwood pulpwood chips poles fence posts • Maple syrup • Fruit, Nuts, Bark • Nursery stock • Tree limbs and tops left after logging • SFIA payments

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

27. 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

28. One forester’s view Consult with your • Tax preparer • Accountant • Legal advisor

29. 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