Timber Income TaxTimber Income Tax

Harry L. Haney, Jr., Ph.D.Harry L. Haney, Jr., Ph.D.Garland Gray Emeritus Professor of ForestryGarland Gray Emeritus Professor of Forestry

Virginia TechVirginia Tech

And Adjunct Faculty at And Adjunct Faculty at

Department of Forestry and Natural Resources, ClemsonDepartment of Forestry and Natural Resources, Clemson

And And

Warnell School of Forestry and Natural Resources, UGAWarnell School of Forestry and Natural Resources, UGA

Timber Taxation Timber Taxation for Forest Landowners ane for Forest Landowners ane Professionals Professionals October 30, 2011October 30, 2011

Arkansas Forestry AssociationArkansas Forestry Association

Little Rock, ArkansasLittle Rock, Arkansas

Holiday Inn AirportHoliday Inn Airport

September 25, 1212September 25, 1212

Timber Income TaxTimber Income Tax• Instructor and Author (Instructor and Author (See Figure 1.1See Figure 1.1))

• Educational materialsEducational materials

• Course purpose is educational, rather than legal Course purpose is educational, rather than legal or accounting adviceor accounting advice

• If in doubt regarding validity of the materials, If in doubt regarding validity of the materials, depend on the teaching notes which are current depend on the teaching notes which are current

• Introductions -- please give name, firm, location, Introductions -- please give name, firm, location, and one unrelated “fact” about yourself and one unrelated “fact” about yourself

Taxes – Some of Timberland Taxes – Some of Timberland Owner’s Greatest ExpensesOwner’s Greatest Expenses

• Federal and state income taxes Federal and state income taxes

• Federal estate and gift taxesFederal estate and gift taxes

• Property and severance taxesProperty and severance taxes

• Sales taxSales tax

• Excise taxesExcise taxes

• Uncertainty of future tax leviesUncertainty of future tax levies

Overview of theOverview of the Federal Income Tax Federal Income Tax

• It is a tax on “net” gain, or profitIt is a tax on “net” gain, or profit

• Investments in the your business or investment Investments in the your business or investment are offset against income in computing gain are offset against income in computing gain

• Expenses to earn a profit are deducted in Expenses to earn a profit are deducted in computing gaincomputing gain

• Currently, capital gains taxed @ 0 and 15%Currently, capital gains taxed @ 0 and 15%

• Ordinary income is taxed @ a max of 35%Ordinary income is taxed @ a max of 35%

• Future is stable for 2 years; uncertain afterwardFuture is stable for 2 years; uncertain afterward

Federal Income Tax ProcessFederal Income Tax Process

Chapter 1Chapter 1

Tax Relief, Unemployment Insurance Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of Reauthorization and Job Creation Act of

2010 (P.L2010 (P.L. 111-312). 111-312)• Extended most of 2001 and 2003 Act -- “Bush Extended most of 2001 and 2003 Act -- “Bush

Tax Cuts” -- provisions through 2012Tax Cuts” -- provisions through 2012

• Extended other provisions that expired at the end Extended other provisions that expired at the end of 2009, but it carries a price tag of $850 MMMof 2009, but it carries a price tag of $850 MMM

• Bonus depreciation allowance extended to 100%Bonus depreciation allowance extended to 100%

• Sec. 179 expensing increased to $125 M in 2012 Sec. 179 expensing increased to $125 M in 2012 with the investment limit extended to $500,000with the investment limit extended to $500,000

Income Tax: AdministrationIncome Tax: Administration• IRS is responsible for implementation the IRC – IRS is responsible for implementation the IRC –

it interprets and enforces the statutesit interprets and enforces the statutes

• IRS Regulations, both statutory and interpretive, IRS Regulations, both statutory and interpretive, are rules prescribed by the Serviceare rules prescribed by the Service

• Regulations have the force of lawRegulations have the force of law

• Revenue Rulings cover specific fact situations, Revenue Rulings cover specific fact situations, but have less force than regulationsbut have less force than regulations

Useful Tax PublicationsUseful Tax Publications• Haney, H.L.,Jr. et al 2001. Haney, H.L.,Jr. et al 2001. Forest Owners’ Forest Owners’

Guide to the Federal Income TaxGuide to the Federal Income Tax.. Ag. Handbook Ag. Handbook No. 718 – see also coop forestry website and No. 718 – see also coop forestry website and note it has been revised and awaits IRS approvalnote it has been revised and awaits IRS approval

• Haney, H.L., Jr. et al 2005. Haney, H.L., Jr. et al 2005. Federal Income Tax Federal Income Tax on Timber: A Key to Your Most Frequently on Timber: A Key to Your Most Frequently Asked QuestionsAsked Questions.. R8-TP 34, U.S. Forest Service R8-TP 34, U.S. Forest Service Cooperative ForestryCooperative Forestry

• 2011 2011 U.S. Master Tax GuideU.S. Master Tax Guide.. CCH, Inc. CCH, Inc.

Other ResourcesOther Resources

• National Timber Tax website @ National Timber Tax website @ www.timbertax.org – funded by the U.S. Forest – funded by the U.S. Forest Service and originally maintained by Purdue Service and originally maintained by Purdue University; has been transferred to UGA University; has been transferred to UGA

• The The IRS Audit ManualIRS Audit Manual

• Hardwood Timber Industry GuideHardwood Timber Industry Guide

Some Timber Tax WebsitesSome Timber Tax Websites• USFS – www.fs.fed.us/spf/coop (Cooperative

Forestry, Washington, DC) and www.r8web.com/spf/coop/taxation (Cooperative Forestry, Atlanta, GA)

• IRS -- www.irs.gov

• UGA -- www.uga.edu/soforext

Forest Activity ScheduleForest Activity ScheduleForm T (Timber) – Rev. Dec. 2005Form T (Timber) – Rev. Dec. 2005• Previous revision was October 2003Previous revision was October 2003• Form T now contains 5 Parts (Appendix A)Form T now contains 5 Parts (Appendix A)• Part I – AcquisitionsPart I – Acquisitions• Part II – Timber depletionPart II – Timber depletion• Part III – Profit or loss from land and timber Part III – Profit or loss from land and timber

salessales• Part IV – Reforestation and TSIPart IV – Reforestation and TSI• Part V – Land ownershipPart V – Land ownership

Forestry Effects on Tax PlanningForestry Effects on Tax Planning

• Effective tax accounting is essential for success Effective tax accounting is essential for success with forestry investment returnswith forestry investment returns

• Keep in context of owner goals:Keep in context of owner goals:– Financial, wildlife, aesthetics, recreation, sentimentalFinancial, wildlife, aesthetics, recreation, sentimental

• Economic returns are driven by:Economic returns are driven by: -- timber growth (inherent productivity) -- timber growth (inherent productivity) -- markets (stumpage prices) -- markets (stumpage prices) -- cost of capital (interest rates)-- cost of capital (interest rates)

Timber ProductivityTimber Productivity

• Yields depend on inherent site qualityYields depend on inherent site quality

• Timber volumes are predictable for any species, Timber volumes are predictable for any species, site index, stocking, and agesite index, stocking, and age

• Figure 1.3 shows yields for various sites of Figure 1.3 shows yields for various sites of native loblolly pine stock in the southnative loblolly pine stock in the south

• Outputs are affected by investment in cultural Outputs are affected by investment in cultural practices – genetics, thinning, fertilizer, and practices – genetics, thinning, fertilizer, and vegetative controlvegetative control

Timber MarketsTimber MarketsPrices are Affected by Supply and DemandPrices are Affected by Supply and Demand

• Stumpage prices shown as averages for South in Stumpage prices shown as averages for South in $ per ton$ per ton from 4Q76 to 3Q10 -- Figure 1.4 – from 4Q76 to 3Q10 -- Figure 1.4 – alternate (Source: Timber Mart-South)alternate (Source: Timber Mart-South)

• Note differentials by product classNote differentials by product class• Short run prices are affected by weather, Short run prices are affected by weather,

inventories, public policies, competitioninventories, public policies, competition• Long run prices are affected by investment, Long run prices are affected by investment,

technology, public policies, competitiontechnology, public policies, competition

TimberMart-SouthTimberMart-South 1818

South-wide Stumpage PricesSouth-wide Stumpage Prices 4 4thth Quarter 1976 –3 Quarter 1976 –3rdrd Quarter 2010 Quarter 2010

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

$50

1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

US

$ p

er

ton

Pine Sawtimber

Pine Chip-n-Saw

Pine Pulpwood

Hardwood Sawtimber

Hardwood Pulpwood

Source: Timber Mart-South

Timber Value GrowthTimber Value Growth

• Financial returns based on physical growth, in-Financial returns based on physical growth, in-growth and quality measuresgrowth and quality measures

• Physical growth as illustrated in Figure 1.3; it is Physical growth as illustrated in Figure 1.3; it is the same as a constant price per unit (ton)the same as a constant price per unit (ton)

• In-growth due to product differentiation with size In-growth due to product differentiation with size – e.g., pulp to chip-n-saw to saw timber– e.g., pulp to chip-n-saw to saw timber

• Value appreciation is due to increasing size, Value appreciation is due to increasing size, quality, specification, volume, operability – see quality, specification, volume, operability – see Effects of Thinning on Value Growth Effects of Thinning on Value Growth – Fig.1.5– Fig.1.5

Value ($)6000

5000

4000

3000

2000

1000

00 5 10 15 20 25 30 35 40

Time (Years)

1- Thin

2- Thin

3- Thin

Cost of CapitalCost of Capital• Generally, land owner’s alternative rate of return Generally, land owner’s alternative rate of return

is a weighted cost of equity and debt (COC)is a weighted cost of equity and debt (COC)

• Opportunity costs include holding land, value of Opportunity costs include holding land, value of growing stock, and annual management costsgrowing stock, and annual management costs

• A simple capital decision rule: hold growing A simple capital decision rule: hold growing stock as long as annual percentage changes stock as long as annual percentage changes equals or exceeds landowner’s cost of capital or equals or exceeds landowner’s cost of capital or alternative rate (does not account for thinning $)alternative rate (does not account for thinning $)

Real and Potential ValuesReal and Potential Values

• LiquidationLiquidation curve – current merchantable curve – current merchantable volume x timber price at any point --volume x timber price at any point -- real terms real terms

• CostCost curve – establishment costs + annual costs curve – establishment costs + annual costs are compounded to any year – are compounded to any year – potential termspotential terms

• IncomeIncome curve – expected harvest revenues - curve – expected harvest revenues - annual costs discounted to any year -- annual costs discounted to any year -- potentialpotential

• Hybrid – solve for IRR and use as discount Hybrid – solve for IRR and use as discount rate -- cost and incomerate -- cost and income curves are the same curves are the same

Timing of Harvest DecisionsTiming of Harvest Decisions

• Optimum harvest values occur at Optimum harvest values occur at tangencytangency of of liquidation and cost curves liquidation and cost curves – (i.e., marginal cost = marginal revenue)(i.e., marginal cost = marginal revenue)

• A decision window occurs at + or - 3 to 5 years A decision window occurs at + or - 3 to 5 years of an optimum rotationof an optimum rotation

• Permits a focus on various goals – marketing, Permits a focus on various goals – marketing, need for funds, personal objectives, value need for funds, personal objectives, value accumulation with minimum potential lossaccumulation with minimum potential loss