The capital gain method often results in significantly lower taxes; however, avoid these pitfalls to prevent the IRS from taking your tax savings!
If you’ve been reading my articles for any length of time, you’ve probably heard me talk at length about the capital gain method. It is the best way for Christmas tree growers to save taxes, often resulting in thousands of dollars of tax savings for the average Christmas tree grower.
However, if you have switched or are considering switching to the capital gain method, you need to make sure you report your income and expenses correctly on your tax return, as well as keep all necessary records to support the tax calculations.
Below is a list of the most common mistakes or “pitfalls” Christmas tree growers make when reporting their Christmas tree sales according to the capital gain method. Make sure to avoid these pitfalls as they could jeopardize your tax savings!
1) Not Properly Reporting Income and Expenses on the Tax Return
Ordinarily, a farm (including a Christmas tree farm) reports its income and expenses on Schedule F of its tax return. However, income and expenses must be reported differently on the return if a grower chooses to make a capital gain election under Internal Revenue Code (IRC) § 631.
Under the capital gain method, qualifying Christmas tree sales must be reported as capital gain income rather than ordinary income. This generally means a grower must report qualifying Christmas tree sales on Form 4797 and Schedule D, in addition to Schedule F. However, the reporting forms and requirements may vary depending on the grower’s tax classification. Also, some other adjustments to account for the fair market value of the trees sold also must be made in certain instances.
2) Electing Capital Gain Treatment on an Amended Return
According to Treasury Regulation § 1.631-1(c), a Christmas tree grower may not make an IRC § 631(a) election on an amended return. A Christmas tree grower must make a capital gain election on their originally-filed tax return, filed by the normal or extended deadline.
3) Not Filing Form T with Your Tax Return
According to the Form T Instructions, Form T must be filed if a § 631(a) election is made. Form T is intended for owners of timberland. However, qualifying Christmas trees are considered timber under the Internal Revenue Code. This means a Christmas tree grower should file Form T with their tax return if a capital gain election is made.
4) Not Taking a Yearly Christmas Tree Inventory Count
A yearly Christmas tree inventory count is important for multiple reasons.
First, it helps a grower determine how many trees to sell. Keeping an accurate record of Christmas tree inventory by height and species will help a grower plan for future sales.
Second, an inventory count will also help determine how many trees a grower needs to plant each spring.
Finally, and most important for tax purposes, an accurate inventory count is important for computing a cost of goods sold or depletion deduction, and will allow for the maximum deduction permissible on the tax return.
I recommend taking a yearly count of all trees on a farm by species and height. Although this may seem like a hassle to count trees by hand, it typically takes no more than one day with two or three people. You can combine walking the fields with technology, such as a Google spreadsheet, to improve counting efficiency. There is also some emerging technology using drones to count Christmas trees.
5) Not Properly Capitalizing Seedling and Planting Costs
A common mistake I see growers make is deducting seedling and planting expenses in the year the seedlings are planted. Instead, growers should capitalize seedling and planting costs, and deduct the cost when the trees are sold. A proper Christmas tree inventory (see #4) needs to be kept to properly deduct seedling and planting costs.
Conclusion
The capital gain method is the top way Christmas tree growers save taxes, often resulting in thousands of dollars of tax savings for the average grower. However, a Christmas tree grower who elects capital gain treatment needs to be aware of the above pitfalls and common mistakes, to avoid jeopardizing their tax savings. I highly recommend consulting a knowledgeable CPA with Christmas tree experience to minimize the risk of costly errors. Feel free to reach out to me if you need help!
