The Qualified Reforestation Expenditures deduction is one of the best ways forest landowners can lower their taxes.
This deduction permits a forest landowner to accelerate the deduction of timber basis, rather than waiting to deduct the associated basis until he sells or harvests the timber.
If you haven’t read them yet, be sure to check out my previous articles in the Back to Basis series that covered why an accurate timber basis is important and how to calculate timber basis under common acquisition scenarios.
What Are Reforestation Expenditures?
According to Internal Revenue Code (IRC) § 194, “reforestation expenditures” are “direct costs incurred in connection with forestation or reforestation by planting or artificial or natural seeding, including costs—
(i) for the preparation of the site;
(ii) of seeds or seedlings; and
(iii) for labor and tools, including depreciation of equipment such as tractors, trucks, tree planters, and similar machines used in planting or seeding.”
As seen in the above language of the statute, most costs to establish or re-establish a stand of timber are reforestation expenditures. Land preparation, seeds or seedlings, planting labor, herbicides, and use of planting equipment are all considered reforestation expenditures.
However, reforestation expenditures do not include timber stand improvements, establishing a Christmas tree plantation, or planting windbreaks or other trees not intended to be harvested as timber.
General Rule
Generally, a forest landowner must capitalize reforestation costs and deduct the costs when he sells or harvests the timber.
This means a forest landowner typically must wait decades to recover their reforestation costs.
Example #1
Orville Oak owns two tracts of timber and keeps separate timber accounts for each tract. In April 2021, Orville incurs total reforestation expenditures of $15,000: $10,000 for Tract A and $5,000 for Tract B.
When can Orville deduct his reforestation expenditures if he follows the general rule?
Orville may deduct his $15,000 reforestation expenditures when he sells the timber. This means Orville will likely have to wait decades to recoup his reforestation costs because the trees he planted must mature before he cuts and sells the timber.
Fortunately, tax law provides two ways for forest landowners to recoup and deduct their reforestation costs quicker.
Exception #1 – Immediate Deduction of Up to $10,000
A forest landowner may immediately expense qualifying reforestation expenditures up to a maximum of $10,000 per Qualifying Timber Property (QTP) according to IRC § 194(b) .
A qualifying timber property is a similar idea to a “tract” of timber. If a forest landowner keeps separate timber basis accounts for multiple timber tracts, they are likely each a qualifying timber property. However, the determination of a QTP is highly fact-specific, so you should discuss your individual situation with a knowledgeable timber CPA if you have multiple tracts of timber.
Example #2
Same as Example #1, except Orville chooses to deduct his reforestation costs under IRC § 194(b).
What is Orville’s Qualified Reforestation Expense Deduction for 2021?
$15,000
Since each tract is a separate Qualifying Timber Property, Orville may immediately deduct up to $10,000 in qualifying reforestation expenditures for each tract. Therefore, he may immediately deduct the $10,000 reforestation expenditures for Tract A and the $5,000 reforestation expenditures for Tract B
Exception #2 – Amortize Costs Over 84 Months
A forest landowner may also choose to amortize and deduct qualifying reforestation expenditures over 84 months (8 tax years) per IRC § 194(a).
Amortization is similar to depreciation and means the total reforestation cost is deducted equally over 84 months.
There is no limit to the amount of reforestation expenditures that may be amortized under § 194(a).
Example #3
Same as Example #1, except that Orville chooses to amortize his entire amount of qualifying reforestation expenditures per IRC § 194(a) instead of immediately deducting them.
What is Orville’s Qualified Reforestation Amortization Expense for 2021?
$1,607 = $15,000 total reforestation expenditures / 84 months * 9 months in 2021 (April – December)
Generally, amortization results in lower tax savings than immediate expensing due to the time value of money. A forest landowner would rather have a $10,000 tax deduction today rather than a $10,000 deduction spread out over 8 years.
Fortunately, amortization may also be combined with immediate expensing of up to $10,000. A forest landowner who incurs more than $10,000 in reforestation expenditures will likely maximize their tax savings using this method of immediately deducting the first $10,000 of reforestation expenses and amortizing any additional reforestation expenses over 84 months.
Example #4
Same as Example #1, except that Orville Oak incurs $9,000 of reforestation expenditures for Tract A and $15,000 of reforestation expenditures for Tract B.
How should Orville maximize his qualified reforestation expenses deduction?
Orville may immediately deduct the $9,000 associated with Tract A because it is within the $10,000 maximum.
For Tract B, Orville may immediately deduct $10,000 and amortize the remaining $5,000 over 84 months.
How Reforestation Expenses Affect Timber Basis
If reforestation expenses are either immediately deducted or amortized, a forest landowner will not have an associated depletion deduction when he harvests the timber decades later.
Although there will not be a depletion deduction to offset the income when a forest landowner sells or harvests the timber, the accelerated deduction results in greater tax savings because of the time value of money. A $10,000 tax deduction today is worth a lot more than a $10,000 deduction decades from now.
Reforestation Expenses and Cost-Share
If a forest landowner receives cost-share payments for reforestation, the reforestation expenses paid for with cost-share funds may not be immediately deducted or amortized under § 194, unless the cost-share payments are included in the forest landowner’s gross income.
For more about cost-share payments, read this Q&A article.
Reforestation Expenses and Entities
Trusts
If a trust owns the forestland, it may not take an immediate deduction of up to $10,000 for reforestation expenses under § 194(b). However, a trust may elect to amortize any reforestation expenses over 84 months per § 194(a).
Partnerships & S-Corporations
The $10,000 expense limitation applies at the entity level, meaning a partnership or s-corporation may not immediately deduct more than $10,000 in reforestation expenses even though each partner will be apportioned a fraction of that $10,000.
However, a partnership or s-corporation may own multiple QTPs and deduct up to $10,000 in reforestation expenditures from each QTP.
Conclusion
Accelerating the deduction of reforestation expenditures is one of the top ways forest landowners can save taxes.
Most forest landowners should immediately expense up to $10,000 of reforestation expenditures and amortize any expenditures over $10,000 to maximize tax savings.
However, each forest landowner’s individual situation is different. Before accelerating deduction of reforestation expenditures, a forest landowner should consult with a knowledgeable timber CPA to determine the best course of action for their individual situation.
Need help deducting qualified reforestation expenditures for your forestland or tree farm? Have questions about how previously deducted reforestation expenditures affect your basis? Contact Andrew today!
Stay tuned for Back to Basis (Part 4), which will cover how to setup timber accounts and properly track their value.
