Timber Transactions (Portfolio 610)

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Bruce N. Edwards

Bruce N. Edwards, Esq., Sorensen & Edwards, P.S.; B.A., The Colorado College; J.D., University of Washington School of Law; LL.M. (in Taxation), New York University; former Law Clerk to the Honorable Shiro Kashiwa, Associate Judge, the United States Court of Claims (now the Court of Appeals for the Federal Circuit); former New Decisions Editor, The Journal of Taxation; repeatedly selected as Super Lawyer, Washington Law & Politics; author, “Fundamentals of Deferring Home Sale Gain,” 27 Tax Management Real Estate Journal 472 (December 7, 2011); “Understanding and Making the New Section 646 Election for Alaska Native Settlement Trusts,” 18 Alaska Law Review 219 (Duke University 2001); “Understanding and Using ‘Partnership Redemptions' in the Context of Section 1(h),” 45 Tax Mgmt. Memo. No. 19, 1 (Sept. 20, 2004); 568 T.M., Involuntary Conversions; 594 T.M., Tax Implications of Home Ownership; Tax Practice Series: Chapter 1510, Tax Free Exchanges; Chapter 1520, Involuntary Conversions; Chapter 1530, Nonrecognition Transactions Upon Sale of Principal Residence; Chapter 2650, Taxation of Timber; Chapter 3850, IRS Audit Procedures; Chapter 3860, Statute of Limitations Chapter 3880, Tax Court Litigation; Chapter 3890, Refund Litigation; member, Washington and Alaska Bars; member, American Bar Association (Section of Taxation, Committee on Court Procedure); member, American College of Tax Counsel.

Table of Contents

Detailed Analysis

I. Timber Dispositions - Introduction

A. Technical Timber Terminology

B. Tax Synopsis of Timber Dispositions

1. Importance of § 1231

2. Before the 2004 AJCA

3. After the 2004 AJCA

II. Dispositions Beginning January 1, 2005

A. Importance of 2004 AJCA

1. Appreciated Timber Property

2. Depreciated Timber Property

B. Statutory Requirements of § 631(b) for Dispositions Beginning January 1, 2005

1. Overview of Competing Concerns Between Buyer and Seller

2. Concept of Retained Economic Interest

3. Concept of Outright Disposition

a. Risk of Loss as a Factor in Characterizing Transaction

b. Unconditional Obligation to Pay for Timber

c. Retained Rights of Seller in Timber Disposition

d. Buyer's Financial Strength

e. Duration of Sale/Seller Reversions

f. Area Sales versus Volume Sales

4. Owner of Timber

5. Holding Period

6. Contractual Disposal

a. Concept of Disposal

b. Dyalwood and Varn - Financing Issues

c. Barclay and Related Cases - The License Issue

d. Date of Contractual Disposal

(1) In General

(2) Election

III. Pre-2005 Dispositions

A. Interplay Between Asset Characterizations and Form of Pre-2005 Dispositions

B. Characterization of the Timber

1. Characterization as a § 1221 Capital Asset

2. Characterization as Property Held For Sale

3. Examples of Characterization Cases - Held for Sale Versus Capital Assets

4. Characterization as § 1231 Quasi-Capital Asset

C. Retention of an Economic Interest

1. Introduction

2. Origination of Retained Economic Interest Concept

3. Criteria for Retained Economic Interest

4. Fixed Payments Under Long-Term Contracts

5. Penalty Payments

6. Assumption of Risk

7. Effect of Legal Title

8. Unstated Interest.

9. Advance and Minimum Royalties

10. Bonuses

D. Other Issues for Pre-2005 Dispositions

IV. Elective Dispositions Through an Owner's Timber Harvest Activities - All Years

A. Relief Afforded by § 631(a) Election

B. Requirements for § 631(a) Election

1. Ownership/Contract Right to Cut

2. Holding Period

a. Time of Acquisition

b. Time Timber Is Cut

3. Cutting for Sale or Use in Trade or Business

4. Election

C. Computation of Gain or Loss Under § 631(a)

D. Application of § 631(a) to S Corporations

E. Qualified Timber Gains for Corporations

V. Long-Term Timber Leases

Introductory Material

A. Tax Consequences to Lessor

1. Part Sale Proceeds/Part Rental Income

2. Imputed Interest

B. Tax Consequences to Lessee

1. Treatment of Payments by Lessee

a. Payments Deductible as Rents

b. Payments Capitalized

2. Imputed Interest

VI. Timber Depletion

A. Overview

B. Depletable Economic Interest

1. In General

2. Concept of "Economic Interest" for Depletion Purposes

3. Depletion versus Basis Recovery

C. Records Required for Depletion

1. Timber Account

a. Subaccounts

b. Timber Blocks

2. Land Accounts

D. Computation of Depletion Allowance

1. Depletion Unit

2. Amount of Allowance

3. Adjusted Basis of Timber

a. Original Basis

b. Adjustments to Basis

4. Timber Units

a. Adjustment to Quantity

b. Adjustment to Basis

5. Timber Units Cut

E. Timing of Depletion Deduction

F. Apportionment of Deduction for Depletion Allowance

G. Form T

VII. Deductions, Credits and Ancillary Considerations

A. Sales Expenses

B. Reforestation and Silvicultural Expenditures

1. Reforestation Expenses

2. Silvicultural Expenses

C. Reforestation Tax Incentives

1. In General

2. Rules Applicable to Reforestation Deduction (Post-2004 AJCA)

a. Qualified Forest Expenditures

b. Amortization over 84-Month Period

c. Trusts and Estates

d. Controlled Corporate Groups

e. Partnerships and S Corporations

f. Recapture

g. Special Relief for 2005 Hurricanes

(1) In General

(2) Definitions

(3) Limitation

h. Making the § 194 Elections

(1) In General

(2) 2004 AJCA Elections Made Before June 15, 2006

(3) Pre-2004 AJCA Elections

3. Rules Applicable to Pre-October 23, 2004 Reforestation Expenditures

4. Investment Credit

D. Cost-Sharing Payments

1. Pre-1978 Revenue Act

2. 1978 Revenue Act

3. Technical Corrections Act of 1979

4. Operation of Gross Income Exclusion

a. In General

b. Reporting Exclusion

c. Election Out of Exclusion

5. Recapture of "Excludible Portion"

a. Amount of Recapture

b. Special Dispositions Limiting Recapture

(1) Transfer at Death

(2) Transfer by Gift

(3) Tax-Free Transfers

E. Road Construction Costs

1. Depreciation or Amortization

2. Road Credits

F. Timber Cruise Expenses

G. Timber to Which § 631(a) and (b) Apply

H. Timber Issues in a Charitable Organization Context

I. Consolidated Returns

J. Corporate Minimum Tax

K. Involuntary Conversions

1. In General

2. Condemnations

3. Casualties

L. Like-Kind Exchanges

1. In General

2. Application to Timber

M. "At-Risk" Rules

N. Passive Activity Losses

O. Information Reporting

P. Section 1038

Q. Deduction for Domestic Production Activities

R. Five-Year Net Operating Loss Carryback for Farming and Hurricane-Related Timber Losses

S. Timber REITs

T. Limitation on Excess Farm Losses

U. Black Liquor Fuel Credit

V. Other Energy Incentives with a Timber Component

VIII. Determining the Fair Market Value of Timber

A. Situations in Which the Fair Market Value of Timber Is Relevant for Tax Purposes

1. Section 631(a) Elections

2. Business Restructurings - Corporation into Partnership

3. Business Restructurings - S Corporation into C Corporation

4. Assets Conveyed Under the Alaska Native Claims Settlement Act

5. Gift Situations

6. Estate Tax Situations

7. Donations to Charity

a. In General

b. Qualified Conservation Easements

c. Bargain Sales

B. The Concept of Fair Market Value

1. In General

2. Factors for Consideration

3. IRS Adjustments

C. Comparable Sales Approach

D. Conversion Return Approach

E. Discussion of Conversion Return versus Comparable Sales

F. Cost to Taxpayer

G. Rents and Royalties

H. Discounted Cash Flow Analysis

IX. Losses

A. In General

B. Depletion Rate Adjustment

C. Loss Deductions

1. In General

2. Limits on Deductibility

a. "Closed" Transactions

b. Definition of Casualty

c. Amount Deductible

(1) In General

(2) Casualty Losses - The "Single Identifiable Property" Concept

(a) Business and Investment Property

(b) Personal Assets

3. Salvage Sales

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Tax Consequences of Timber Disposition Events For Timber Held More Than One Year Before 2004 AJCA

Worksheet 2 Tax Consequences of Timber Disposition Events For Timber Held For One Year Or Less Before 2004 AJCA

Worksheet 3 Tax Consequences of Timber Disposition Events For Timber Held More Than One Year Following 2004 AJCA

Worksheet 4 Tax Consequences of Timber Disposition Events For Timber Held For One Year Or Less Following 2004 AJCA

Worksheet 5 Form of Cutting Contract for Disposal of Timber with Retained Economic Interest Under § 631(b) and Advance Payment

Worksheet 6 Form of Timber Sale Agreement for Outright Sale of Timber with Installment Payments

Worksheet 7 Excerpt from Internal Revenue Manual - Audit Techniques Relating to Forest Industry Taxpayers

Worksheet 8 Excerpt from an Audit Technique Guide for the Hardwood Timber Industry (Feb. 1998) Under the Market Segment Specialization Program ("MSSP Guide")

Worksheet 9 Industry Specialization Program Coordinated Issue Paper on Losses of Timber Following an Epidemic Attack of Southern Pine Beetles

Worksheet 10 Industry Specialization Program Settlement Guidelines for Expenditures for Replanting Forest Plantations That Fail

Worksheet 11 Industry Specialization Program Settlement Guidelines for Capitalizing Reforestation Costs

Worksheet 12 Industry Specialization Program Guidelines for Computation of Timber Casualty Losses

Worksheet 13 Industry Specialization Program Decoordinated Issue Paper - Plantation Losses Due to Severe Drought

Worksheet 14 Industry Specialization Program Settlement Guidelines for Logging Roads - Depreciation and Investment

Worksheet 15 Form T - Forest Activities Schedule

Worksheet 16 Sample Statement Relating to Cost-Sharing Payments Under § 126(c)

Worksheet 17 Sample Statement Electing Seven-Year Amortization for Reforestation Expenditures Under § 194

Worksheet 18 Sample Election Under § 631(b) to Treat Date of Payment as Date of Disposal of Timber

Worksheet 19 Selected Excerpts from the Legislative History of the Alaska National Interest Lands Conservation Act, P.L. 96-487 (1980), S. Rep. No. 413, 96th Cong. 2d Sess. 256-257 (1980)

Worksheet 20 Selected Excerpts from the Legislative History of the Farm Security and Rural Improvement Act of 2002

Worksheet 21 Selected Excerpts from the Legislative History of the American Jobs Creation Act of 2004




Treasury Regulations:

Temporary Regulations:

Legislative History:

Treasury Rulings:

Internal Revenue Manual:

USDA Publications: