1. Family Forestland Ownership as a Business Presented by Mike Reichenbach Regional Extension Educator University of Minnesota 10/2008

2. Items to be covered Operation as a business –Advantages –Documentation Your management plan Your forest journal Timber sales -- income and expenses Forest hobby

3. Participants will be able to Make a decision regarding operation as a business, investment or hobby Provide their tax preparer with information about income taxes for family forest landowners Explain why returns and costs of forest mgmt should be in the forest mgmt plan Will be able to use a forest journal

4. Do you have a forest management plan? 10 1.Yes 2.Yes, it has not been updated > 10 years 3.No, I own > 20 acres of forest 4.No, I own < 20 acres of forest

5. Do you keep a journal of activities and actions that you carry out on your forestland? 1.Yes 2.No 3.I do not own forestland 10

6. Exercise and discussion Page 1 of the Forestland Journal

7. Do you operate your forestland as a 10 Pick the number that best describes the operation of your forestland. 1.Business 2.Investment 3.Hobby 4.I do not own forestland 5.I am not sure

8. Types of business income Active -- owner(s) take actions to protect and enhance the value of the asset and meet one of several -- material participation or time involvement tests Passive -- owner(s) take actions to protect and enhance the value of the asset but do not meet any of the time involvement tests Investment -- owners(s) expect appreciation in value and treat the land as they might a bond

9. Is it a business? Profit three out of five years IRS presumes you are a business otherwise Proof is up to the taxpayer

10. Can you operate as a business if you do not plan to harvest timber? 10 1.Yes 2.No

11. Is it a business? 1.Manner in which the activity is conducted 2.Expertise in the activity 3.Time and effort required 4.Expectations of appreciation in value

12. Is it a business cont. 5.Previous success in similar activities 6.History of income or losses 7.Amount of profits or expected profits 8.Financial status 9.Elements of personal pleasure

13. How might you show you are in business? Developing a timber management plan Belonging to a forestry association Enrolling in the Tree Farm Program Attending forestry classes Maintaining a forest journal

14. Material participation tests Any one of the following; 1. >500 hours. 2.You do all the work. 3.Spend >100 hours and no one participated more. 4.Spend >100 hours in forestry and >500 hours in other businesses. 5.Materially participated in any 5 of last 10 years. 6.Other facts & circumstances (>100 hours, no paid manager, no paid staff participate more).

15. Additional considerations You and your spouse are considered one Retired or disabled, you are considered materially participating if you did so for at least 5 of the previous 8 years You do not need to pass the same test each year Record keeping is essential

16. Forest income and expenses ActivityInvestmentPassiveActive Timber Sale/lump sum or pay as cut Capital gain Mgmt expenses Misc. itemized deduction or capitalize Deduct from passive income or capitalize Deduct from any income

17. Why operate as a business? Capital gains treatment of income = lower tax rates ~ 15% Deduction of expenses from any income (active business only) No self-employment tax on capital gains No reduction of social security benefits (not considered earned income)

18. How would you like to operate your property? 20 Pick up to two numbers that best describes your future intention. 1.Business 2.Investment 3.Hobby 4.I do not own forestland 5.I need more information 6.I need more time 7.I have decided

19. Exercise and discussion Page 2 of the Forestland Journal

20. Timber sales; income and expenses Lump sum and pay as cut net proceeds are treated as capital gains. (must hold timber more than one year) Sale of logs, 631 (a) sales Form T

21. Active business Timber sales income Report on Form 4797, Part I Management, taxes & interest expense Deduct from any income and report on Form 1040, Schedule C or capitalize (only if no income)

22. Passive business Timber sales income Report on Form 4797, Part I Management, taxes & interest expense Deduct from passive income Report on Form 8582, or capitalize

23. Investment Timber sales income Report on Form 1040, Schedule D, part II Management Expenses: Report on Form 1040, Schedule A Deduct to extent costs exceed 2% of AGI or Capitalize Taxes: Deduct from any income or capitalize Report on Form 1040, Schedule A Interest: Deduct from net investment income or capitalize

24. Sale of logs 631(a) sales result in both capital gains and ordinary income Capital gain is Section 1231 gain - Reported on Form 4797. Ordinary income is reported on Schedule C or F

25. Use Form T if You claim a timber depletion deduction You make a Section 631 (a) election You sell timber Optionally for acquisitions, profits, losses from timber sales, reforestation and silvicultural activities or changes in land ownership A good way to keep track of timber basis

26. Timber sales; expenses Operating expenses Capital expenses –Depreciation –Section 179 Election –Amortization –Depletion allowance

27. Operating expenses –Tools with a short useful life –Salaries –Travel Ordinary and necessary Directly related to income potential

28. Capital expenses Land Timber Buildings Machinery & equipment >1 year Major repairs to machinery & equipment Tree planting Permanent roads, bridges, firebreaks Money used to acquire or improve capital assets

29. Depreciation and equipment The process by which the cost (basis) of a personal property is recovered (deducted from income). Depreciation schedules. Land, timber, buildings and equipment –Must be used to make money –Must have a useful life of > 1 year –Must be something that wears out or is used up

30. Section 179 Election Deduct all or part of the cost of personal property the year it is placed in service Elect in the year property first placed in service Limits –Maximum annual limit is $250,000 (increased for one yr from 125K –$250,000 deduction is reduced $1 for each $1 of personal property investment over $800,000 –Deductions are limited to the amount of taxable income from active conduct of a any of your businesses, carry forward excess Report: Form 4562 Information: IRS Publication 946

31. Amortization and tree planting After October 21, 2004 < $10,000 of reforestation expenses maybe deducted > than $10,000 of expenses are amortized over 8 years.

32. Timber sales and depletion Deduct from income Timber sale expenses Depletion allowance Sale expenses include: –Advertising –Timber cruise –Marking –Scaling –Consulting fees

33. Timber sales and depletion Depletion allowance = (total basis/total volume before the sale) x number of units sold Original cost (basis) recorded in an account Adjustments to original cost (basis) –New expenses will increase the basis –Timber sales will reduce the basis

34. Example: depletion allowance Merchantable Timber Account Date Description Amount$ Basis 9/01timber purchase 2000 cords$40,780 10/07 current volume 2,695 cords$40,780 11/07timber sale (1,000) cords($15,130) 11/07net 1,695 cords$25,650 Depletion Unit: $40,780 ÷ 2,695 cords = $15.13/cord Depletion Allowance: 1,000 cords sold x $15.13/cord = $15,130

35. Example: timber sale 18,000Timber sale income (1,800)Consulting forester ( 70)Advertising (15,130)Depletion allowance 1,000Net income Report $1,000 of capital gain on Form 4797, Part I

36. Other woodland income Report as ordinary income: Products derived from trees lumberfuelwood pulpwoodchips poles fence posts Maple syrup Fruit, Nuts, Bark Nursery stock Tree limbs and tops left after logging SFIA payments

37. Form 1099 There is confusion about when and what forms to use 1099S is used for pay as cut contracts and is appropriate for lump-sum acquisitions 1099MISC is often used, resulting in the IRS looking for a match on the sellers tax return under ordinary income This can be a problem if the seller is operating as a business. Always consult your tax advisor

38. If you are not in business, how are costs recovered?

39. Hobby Property taxes may be deducted Timber sale expenses may be deducted as an itemized deduction and reduce your taxes only if the expenses exceed 2% of your gross income Timber sale income is ordinary income You are subject to self-employment taxes

40. One forester’s view Consult with your –Tax preparer –Accountant –Legal advisor

41. Sources of information Forest Landowners’ Guide to the Federal Income Tax: www.fs.fed.us/spf/coop/ www.fs.fed.us/spf/coop/ National Timber Tax Website: www.timbertax.orgwww.timbertax.org Mel Baughman, (612) 625-1288, baughman@umn.edubaughman@umn.edu Mike Reichenbach, (218) 726-6470, reich027@umn.edureich027@umn.edu Geary Searfoss CPA, (715) 266-8290