Do I Have To Pay Income Tax on My Timber Sale?

I was meeting with a landowner about his timber sale I recently marked and sold for him.  He had a timber sale 11 years ago and I asked him about how much depletion he took on that sale.  He had no idea what I was talking about.  I started explaining that he should not be paying income tax or should be taking large deductions from timber income.  I decided to research sources for him on how to pay tax on timber sale income.

Do you have to pay income tax on a timber sale?  Yes.  You will receive a 10-99 form from the saw mill and you will have to report that income.  However, by using a good Consulting Forester and a knowledgeable accountant, you can get great advice on how to reduce or eliminate your tax burden on that income.  Here’s how:

Calculate the Cost Basis for Your Timber

The first step is to calculate the basis of the timber portion of the investment in your land at the time of purchase or, in the case of an inheritance, at the time of death of the decedent.

A Consulting Forester Can Help You Establish Your Cost Basis

Your Forester will cruise the timber and establish the volume of sawtimber and pulpwood and an estimate of value for all of the timber products on your land at the time it comes into your possession. This step is extremely important.  Once this figure is established you will allocate that dollar amount to purchase by the percentage of the price you pay.  In the case of an inheritance, you may want to get a real estate appraiser to evaluate the total property value.

Take the amount the saw timber and the pulpwood is worth divided by the total value and you get a percentage.  That percentage times the purchase price is the cost basis.  For instance, say you buy a farm property for a million dollars and it has a 50-acre woodlot.  I cruise the timber in the 50 acre woodlot and the volume is 200,000 board feet sawtimber and 1,000 tons of pulpwood.  I value the sawtimber at $50,000 and the pulpwood at $3,000.

Later, we do a timber sale and I mark 100,000 Board Feet of timber and sell it for $30,000.  Do you pay taxes on that as ordinary income?  No, because you were smart enough to hire a Forester.

Taking a Depletion Allowance for Timber Sold

Your investment in the timber when you bought the land is a commodity.  So, you can take a depletion deduction when you sell it.

To find out what your deduction is you take your timber basis figure and divide it by the volume.  This is your depletion unit.  In this case your depletion unit is $50,000 / 200,000 = $.25.   Now take the 100,000 BF I sold times the .25 and your deduction from the timber sale is $25,000.  So now you can subtract that from the $30,000 and your income from the timber sale is only $5,000.

Capital Gains Taxes on Timber Sales

Now, even better, this income is subject to a capital gains tax rate.  Depending on your income this will be from 0 to 25%.  If you make less than $77,200 as a married couple, you don’t pay tax on that income.  If more your tax burden is only $1,000 or so…a lot better than paying 30 or 40 percent of the whole $30,000.

How to Calculate Your Timber Sale Tax on Your Tax Return

You will need to figure these calculations on a Form T.  There is also a Form 4797 having to do with disposition of a capital asset.  This is not stuff for H & R Block.  Get a good accountant who knows about timber sales or can educate himself on the subject.

Hiring a Consulting Forester is a Good Investment

Can you see where it pays to be an active investor in your timber and to manage the timber as an income producing asset by utilizing Consulting Forestry Services?  If you hired me to do the timber sale and paid me $3,000, not only do you get more for your timber sold, you sold the right timber at the right time and did not ruin your future growth.  You also can save substantially on your timber sale income tax, more than paying for the cost of the services.

Note that if you sell your timber to a logger on a percentage basis, you have to take that income as ordinary income.  I don’t know why that is but you can see that selling your timber this way is a bad move.  Not only are you selling it for less than it’s worth, you don’t get to deduct the depletion allowance because you don’t have a Forester to tell you what that is.  Unfortunately, most timber is sold this way and folks are paying way to much income tax.

I should be getting called to cruise timber on every purchase of forested land to establish a cost basis in that timber.  But in all my years of service to landowners, I have never once been asked to do so.  Too bad.

Be an Active Manager of Your Woods

Every time you go to your land and walk around with a chainsaw doing TSI, or planting or using herbicides, record it.  Your activities are tax deductible.  Your mileage and expenses should be recorded.

Any expenses you incur in active forest management are also deductible up to $10,000.  So, hiring me to bring a crew up to do TSI, herbicide applications, etc are deductible, plus they establish that you are an active investor in your timber, giving you investor status.  This is important as timberland can be owned for personal enjoyment, as an investment, or as a business.  Owning it for investment or business and showing that by actively managing it gives you more beneficial tax treatment.

For more detailed information check out this website that the U.S. Forest Service maintains.  Its pretty good.

The important takeaway here is that you should have a long-term working relationship with your Forester same as you would with a good lawyer and an accountant.  We are on your side.

Here is a Form T for some light reading. Enjoy:

Form T