Many small farmers and homeowners own small parcels of timber on their land. After the April 2011 tornados, hundreds of acres of timber were blown down. A significant amount of this timber was harvested and sold. As economists, we received numerous questions asking how these timber sales were supposed to be reported on individual tax returns. Our answer generally was "It depends."
Woodland property may be taxed under one of three tax classifications:
Investment (income-producing) property or
These classifications depend on how you use your timberland, the reason you purchased the land and what activities happen on your timberland. Since so many of the questions we received after the tornadoes were from homeowners, small landowners and farmers, we will focus in this article on their needs. If you are in the commercial timber business, there are many publications specific to your needs.
Normally, the first question from farmers and small landowners is "Where do I report the sale of timber?" Generally speaking, gains from sale of personal property are taxed as capital gains like stock sales.
The next question generally is "What is my basis (cost) in this timber?" Taxpayers don’t want to pay taxes on the gross dollar amount of the timber sale if there are costs they can deduct from the sale.
To determine the cost of your timber, you need to know the planting costs, maintenance costs and costs associated with cutting your timber. Here are a couple of questions any farmer or small landowner should consider discussing with your tax advisor.
First, let’s consider the cost of the timber when you first became the landowner.
When did you inherit or purchase the timber? How many years ago was this?
Is the timber part of a farm or a separate plot of land?
In either situation, was there an appraisal done on the value of the timber when you inherited or purchased the property?
Next, let’s consider the costs of planting and maintaining your timber.
For farmers, were any of the costs associated with timber deducted on prior year tax returns? Timber planting costs include site preparation, seedlings, consulting forester’s fees and others. Timber maintenance costs include a wide variety of potential costs including tree trimming and other costs incurred in keeping your timberland in good shape.
Unfortunately, many small farmers and landowners cannot answer these questions due to poor records. If they spent $10,000 in planting costs 15 years ago, they either no longer have the documentation to prove the expenditure or to determine whether this $10,000 was previously deducted on their tax return in prior years.
Our best recommendation for these types of questions is to begin a diary or journal for your small timber holdings. Use this diary to write down everything you have done to your timber holdings. If you spent money, make a note of how much, the reason for the expenditure and the vendor you paid. If you have more than one plot of timber land, note which parcel the money was spent on. Also, make a note whether this expense was deducted on a tax return and what year.
Over time, this journal or diary will become more and more valuable to you. Take pictures or draw maps of your plot and tape them in your journal or diary over the years. A simple journal or diary like this could have saved farmers and small landowners significant taxes since the April 2011 tornado.
Finally, it will be time to harvest and sell your timber because (a) you want to or (b) because you have to due to storm, fire or tornado damage. This journal will help determine your investments or costs in your timber that have not previously been reported on a tax return. These costs may have been incurred over 5-25 years.
In addition to prior year costs, you have current year timber costs. You will have the costs associated with cutting and selling your timber in the current tax year. Putting these prior year and current tax year costs together will form your cost basis for your timber sales.
Timber can be considered as a long-term investment or simply as a cost to improve the look of your farm or personal property. In either case, make sure your records are adequate.
For additional information on timber sales, we invite you to visit the Alabama Cooperative Extension System’s website at www.aces.edu and type "timber sales" in the search window. There are many excellent articles on ACES’s website that you may find interesting. A little research and a talk with your tax advisor this year may save you thousands of dollars in taxes for future timber sales.
For more information about farm management and financial analysis, please contact your County Extension Coordinator or an Extension Specialist: North Alabama: Holt Hardin, 256-574-2143 or Robert Page, 256-528-7133; Central Alabama: Jamie Yeager, 334-624-4016; Southwest Alabama: Steve Brown, 251-867-7760.