Southern Ag Today

Author: Yanshu Li

  • Do I need to pay the Net Income Tax on my timber income?

    Do I need to pay the Net Income Tax on my timber income?

    The short answer is: It depends. The slightly longer answer is that it is determined by the classification of your timber holding, the way to sell the timber, and your modified adjusted gross income (MAGI) for the year. 

    What is the Net Investment Income tax?

    NIIT, also known as the Medicare surtax, is an additional tax applicable to high-income individuals, estates, and trusts with significant investment income. More specifically, it is a 3.8% tax on the lesser of: (1) net investment income or (2) the excess of MAGI over a threshold ($250,000 for married filing jointly and $200,000 for single taxpayers). The tax went into effect in 2013. 

    Generally, net investment income includes: (1) interest, dividends, capital gains, annuities, royalties, and rents not derived in a trade or business; and (2) income from businesses that are passive activities to the taxpayer. Wages, unemployment compensation, operating income from a nonpassive business, Social Security benefits, tax-exempt interest, and self-employment income are not subject to the NIIT. 

    Timber income and the NIIT

    For federal income tax purposes, your timber activity generally can be classified into one of three categories: 1) for investment; 2) material participation in a trade or business; and 3) passive activity where your participation in a trade or business does not rise to the level of material participation. Due to the level of involvement, most non-industrial private forest landowners fall in the investor category. Farmers with occasional timber sales may treat their timber as property held for sale or use in a business. An example of passive activity is the limited partner in a partnership.  

    For investors, income on the sale of standing timber is a capital gain. Depending on the holding period, it can be long-term or short-term, but it is usually included in the net investment income for NIIT. 

    If the standing timber is held in a trade or business for more than one year and sold in a lump-sum or under a pay-as-cut contract, the income generally qualifies for the long-term capital gains tax treatment. Income from the sale of cut timber normally is ordinary unless a 631(a) election is in effect. Under the special election, the income from holding the standing timber is treated as a long-term capital gain, while the portion of the income from selling the cut timber is ordinary income. 

    If you materially participate in a trade or business, your timber income from the business is not subject to the NIIT, even if it is treated as a long-term capital gain. However, it is subject to the NIIT if your timber activity in a trade or business is passive and your MAGI is over the threshold.

    Strategies to manage the NIIT for timber owners

    If you can substantiate your timber activity as material participation in your timber business, you can enjoy the long-term capital gains tax treatment of your timber income and won’t have to worry about owing the NIIT on it. However, your timber income may push your MAGI over the threshold and trigger the NIIT on non-timber investment income. Therefore, you may want to manage the timing of your other investment income when you expect to have a significant timber income. 

    For more information about timber taxation, please see https://www.timbertax.org/publications/fs/taxtips/TaxTip2022.pdf

    This publication is for informational and educational purposes, but is not intended as financial, tax, or legal advice.Please consult with your tax advisor concerning your particular tax situation.

    Li, Yanshu. “Do I need to pay the Net Investment Income Tax on my timber income?” Southern Ag Today 3(10.3). March 8, 2023. Permalink

  • Tax Tips for Forest Landowners

    Tax Tips for Forest Landowners

    From planting trees to conducting timber sales, there are many things for landowners to consider when owning a timber property. Many forest landowners think about taxes only after they had a timber sale. However, there could be tax implications for each timber activity. It is important to conduct tax planning carefully. 

    Here are a few tax tips for forest landowners to consider.

    1.         Know the classification of your timber holding

    Your timber holding classification is the first step in figuring out the federal income tax consequences of your timber activities. The classification determines which tax rules are applicable. Timber holding generally could be classified as one of the following three types: 1) property for personal use or as a hobby (not-for-profit); 2) property held as an investment; or 3) property held in a trade or business. Generally, you will get the best tax advantages if you materially participate in a timber business.  

    2.         Understand timber sale income and capital gains tax

    When you have a timber sale, you are taxed on the net income, rather than the gross proceeds. You are allowed to subtract selling expenses, timber depletion allowance, and yield tax from the revenue to get the net taxable gain. In most cases, the income from a standing timber sale is taxed at favorable long-term capital gains tax rate (0%, 15%, or 20% depending on the taxable income) if the timber has been owned for more than one year. If your timber is inherited, the gain is considered long-term in nature regardless of how long you have owned the timber. 

    3.         Take advantage of the reforestation tax incentives

    Eligible forest landowners may deduct up to $10,000 (married filing jointly) in qualifying reforestation expenditures per year per qualified timber property and amortize the rest over 8 tax years. You make the deduction against taxable income from all sources. 

    4.         Recover operating expenses and carrying charges

    If you materially participate in the timber business, you can fully deduct ordinary and necessary expenses associated with carrying on the business. For 2018 through 2025, forest landowners who hold timber as an investment are not allowed to deduct eligible operating expenses as itemized deductions. You may consider capitalizing (adding to basis) certain forest management expenses and carrying charges with proper tax elections. Timberland property taxes can still be fully deducted if you itemize. 

    5.         Keep track of timber basis

    Timber basis is generally the amount of capital investment in the timber. If the forestland was purchased, the original timber basis is the amount of the total acquisition costs allocated to the timber. If the property was inherited, the timber basis generally is its fair market value on the decedent’s date of death. If the property was received as a gift, the basis is generally the donor’s basis plus the gift tax. 

    6.         Claim timber casualty loss deduction when a natural disaster hits

    Timber loss caused by a casualty event (e.g., hurricane, storm, fire) may be tax-deductible. A forest landowner may deduct the lesser of the basis or the decrease in the fair market value of the affected timber block caused by the casualty.

    7.         Consider excluding cost-sharing payments

    Some conservation-oriented cost-sharing payments from qualified government programs qualify for partial or full income exclusion.  

    8.         Take advantage of the Qualified Business Income (QBI) deduction if applicable

    If your timber business has received ordinary income from selling cut timber products, pine straw, live trees, or other products, you may consider taking the QBI deduction. It is available for tax years 2018 through 2025. 

    9.         Smooth out timber income over years

    You may consider using an installment sale approach (lump-sum contract) or a pay-as-cut contract to smooth out your timber income over several years if such an arrangement can minimize total taxes. 

    For more details on these tax tips as well as others, please see the publication: https://www.timbertax.org/publications/fs/taxtips/TaxTip2021.pdf.

    Disclaimer

    The material herein is for general informational and educational purposes only and is not intended as financial, tax, or legal advice. Please consult with your tax advisor for advice concerning your particular tax situation. 

    Li, Yanshu. “Tax Tips for Forest Landowners“. Southern Ag Today 2(10.3). March 2, 2022. Permalink

  • Southern Timber Market Update

    Southern Timber Market Update

    Lumber prices have been on a roller coaster since the pandemic. They skyrocketed to a record high in May 2021, about quadruple the pre-pandemic five-year average prices, retreated swiftly over the summer, and started to surge again since mid-September. Lumber prices have made headlines and even been addressed by the Federal Reserve Chair. The South is often considered the wood basket of the country because of its significant role in wood supply. People would naturally think that southern timber prices increase dramatically as lumber prices soar because sawmills use timber as raw material to produce lumber. Timber prices and lumber prices are even used interchangeably by some news reporters. However, lumber and timber products are governed by different demand and supply factors. 

    Despite the marked rise in lumber prices, timber prices in the South have barely increased in the past two years until recently. According to TimberMart-South (TMS), the average southern sawtimber price (nominal) hovered around $23-25/ton from 2010 to 2020, compared with $37/ton in 2007. The southern timber market was among the hardest hit by the 2008-2009 economic recession. Roundwood harvest in the South dropped more than 30% compared to the peak in 2007 and timber prices declined more than 40%. Most mills curtailed their production. Some less efficient mills closed permanently. Trees continue to grow vigorously no matter what is going on in the economy. As a result, a significant volume of sawtimber has been accumulated on the stump over the past decade.  Although demand for timber products has gradually improved with improvement in the housing market, the amply supply of standing timber has put constant downward pressure on timber prices in the region. 

    Fortunately, landowners have started to see a gradual increase in timber prices in 2021. Timber prices across the South averaged at $26.24/ton in the third quarter, a 15% increase year-over-year. In some parts of the region (e.g., South Georgia, Florida, and East Alabama), the prices could be more than $45/ton due to strong demand from local sawmills. Record high lumber prices and continued improvement in the housing market support investment in sawmills. Softwood lumber production capacity in the South has increased 2.9 billion board feet (bbf) from 2017 to 2020, an increase of 16%. Newly announced greenfield construction and existing mill expansion suggest that the capacity could increase by another 3.0 bbf by 2023 (TMS). Canadian firms account for most of the increase mainly due to the high timber costs in Western Canada. This is good news for private forest landowners in the South since the increased demand is likely to translate into higher timber prices. 

    Whether the recent rise in timber prices can be sustained largely depends on factors from the demand side. Positive signs include a stable growth in single-family housing starts, continued increase in home improvement and repair expenditures, sawmill capacity expansion, and recovery in log exports. Additionally, the U.S. Department of Commerce recently announced that it will double the tariffs on Canadian softwood lumber to 17.9%. This may push U.S. domestic lumber prices even higher but may also accelerate the pace of Canadian firms’ investment in southern lumber mills. Overall, standing timber prices are expected to hold their recent strength in the near term. However, supply chain disruptions and labor shortage in the logging, transportation, and sawmilling sectors add uncertainties to the market. 

    Li, Yanshu. “Southern Timber Market Update“. Southern Ag Today 2(2.3). January 5, 2022. Permalink