Every forest landowner should setup and properly maintain timber capital accounts to maximize their tax deductions.
If you have not read them yet, be sure to check out my previous articles in the Back to Basis series that covered what basis is and why it matters, how to calculate an accurate timber basis under different scenarios, and saving taxes with qualified reforestation expenditures.
What are Timber Capital Accounts?
Timber Capital Accounts are simply accounts in a forest landowner’s bookkeeping system that track the cost of certain assets. These timber capital accounts normally make up a substantial portion of a forest landowner’s balance sheet.
Generally, most forest landowners should use at least four different categories of timber accounts:
(1) Land Account;
(2) Depreciable Land Improvements Account;
(3) Timber Account; and
(4) Equipment Account.
1) Land Account
The land account should track the cost basis of the land itself, as well as any land improvements that are not depreciable.
The cost of the land itself, as well as nondepreciable land improvements, are not depreciable. This means a forest landowner will not receive a tax deduction for the cost of these assets until they are sold or disposed of.
Nondepreciable land improvements are typically “permanent” improvements, such as permanent roads, land grading/leveling, land clearing, dam construction, and any other improvements that will benefit the land indefinitely.
2) Depreciable Land Improvements Account
The depreciable land improvements account should track the cost basis of all land improvements that are eligible for depreciation. In contrast to “permanent” nondepreciable land improvements, depreciable land improvements typically wear out and have a definite useful life. Depreciable land improvements include fences, bridges, temporary logging roads, temporary firebreaks, and graveling.
3) Timber Account
The timber account should track the cost basis of all timber, as well as the estimated quantity of timber. Further, the timber account should contain any applicable subaccounts to make recordkeeping easier and more useful to the timberland owner.
Timber subaccount categories often include merchantable timber (timber ready to sell), young growth (young trees acquired with the land that are not ready to sell yet), and plantations (tree stands established after the land was acquired). The timber accounts or subaccounts can also track other variables such as tree species and location.
How the timber accounts are structured in regards to location is especially important for determining any applicable casualty loss deduction. A casualty loss deduction is typically calculated based on a “single, identifiable property (SIP).”
For timber purposes, an SIP is typically based on the “depletion block” or the trees established at the same time that have the same cost basis. However, an SIP can also be based on the amount of timber damaged or lost in terms of cords, board feed, or other timber measurement.
4) Equipment Account
A timber owner should also track the cost basis of any equipment they own and use in their timber activity, such as vehicles, chainsaws, ATVs, and other machinery. The cost of equipment used in a timber activity often qualifies for a depreciation deduction. The type and timing of the depreciation deduction depends on how the activity is classified. Special depreciation allowances, such as 179 expense and bonus depreciation, can result in significant tax savings for a timber owner.
Allocating Original Basis
The first step to properly setting up timber accounts is to allocate original basis correctly between each type of asset acquired, such as land, land improvements, and timber. For an in-depth look at calculating and allocating original basis, read Back to Basis (Part 2).
Maintaining Basis
After original basis is properly calculated, a forest landowner will also have to properly maintain basis by adding, subtracting, and adjusting the capital accounts based on events that occurred during the tax year.
For example, when new seedlings are planted, the timber account will increase based on the cost basis of the new seedlings and associated planting expenses.
The depreciable land improvements account is usually adjusted yearly by adding the cost of any new depreciable land improvements, subtracting the cost of any disposals, and adjusting for yearly depreciation expense. Yearly depreciation expense is also often tracked in a separate account.
Also, when assets are disposed of, they should be subtracted from the appropriate account. For example, when a piece of equipment is sold or disposed, its cost should be subtracted from the equipment account along with an adjustment to an accumulated depreciation account.
Cost-Share and Qualified Reforestation Expenditures
The previous section discussed the general rule to maintain basis accounts. However, an exception exists for assets acquired using cost-share funds, as well as the cost of new stands that are deducted using Qualified Reforestation Expenditures.
Cost-share payments are payments from a government agency to a forest landowner to help offset the cost of reforestation or other forest improvement projects.
Frequently, cost-share payments for capital improvements (such planting new trees or building forest roads) are excludable from income. If the cost-share payments are non-taxable, the associated capital accounts may need to be adjusted to avoid a “double deduction” for a capital improvement or expense.
However, a forest landowner may always include the cost-share payment in taxable income and deduct the associated cost. The tax calculation should be figured both ways to determine which method results in the lower tax liability for the forest landowner.
More information about Cost-Share Payments and Qualified Reforestation Expenditures may be found by clicking the links to my previous articles.
Conclusion
Every forest landowner should setup and properly maintain timber capital accounts to maximize their tax deductions, as well as to be prepared in the event of an IRS audit.
Most forest landowners should at least have a Land Account, a Depreciable Land Improvements Account, a Timber Account, and an Equipment Account. Additional accounts and subaccounts may also be used for more accurate recordkeeping.
After setting up the correct accounts, a forest landowner must properly calculate original basis and maintain basis moving forward. Finally, cost-share payments and Qualified Reforestation Expenditures will require special calculations on the tax return and may require adjustments to the capital accounts.
Stay tuned for the fifth and final installment of the Back to Basis series which will explore how to report basis on Form T.
Stumped about setting up or maintaining your timber capital accounts? Contact Andrew for help!
