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Non-business Structures

Personal Use - Title to the timberland is in name of the taxpayer. Property taxes are reported as itemized deduction of Form 1040, Schedule A. The timber is a "capital asset" and if sold on the stump qualifies for capital gains treatment which is reported on Schedule D, Form 1040. Timber management expenses are not deductible and must be capitalized to the appropriate capital account.

Hobby - Title to the timberland is in name of the taxpayer. Property taxes are reported as itemized deduction of Form 1040, Schedule A. The timber is a "capital asset" and if sold on the stump qualifies for capital gains treatment which is reported on Schedule D, Form 1040. Timber management expenses are deductible under the provisions of the "hobby loss rule," only to the extent of current income from from the tree farm. This is because it is not held primarily for the production of income. Deductions allowable under the hobby loss rules are not subject to the passive activity loss rules.

Investment - Title to the timberland is in the name of the investor(s). Joint title may be appropriate if timber income will be realized during the investor's lifetime and spreading income among taxpayers maximize net after-tax income in the hands of the beneficiaries. If most of the tree farm wealth is to be transferred at death, concentrating ownership in as few individuals as possible will maximize the step-up in basis.

Property taxes are reported as an itemized deduction. Management and carrying costs are reported as miscellaneous itemized deductions of Form 1040, Schedule A, and are subject to a 2-percent of adjusted gross income (AGI) floor. This means that the deductions provide provide a tax benefit only to the extent they exceed this limit. Interest deductions are also limited. Deductible costs include timber management expenses, since the timber is held primarily for the production of income. The timber is a "capital asset" and if sold on the stump the gain (loss) qualifies for capital gains treatment, reported on Schedule D, Form 1040. The passive activity loss rules do not apply to investment expenses.

An investment is an activity carried out for profit but one which does not involve as much "work" as is normally associated with a business. A business is normally characterized as an activity comprising your major source of income. The distinction is relative, and the IRS does not provide hard-and-fast rules for making this distinction. Historically this distinction has not been very important, based on the small amount of case law dealing with this issue in general and timber in particular.

How big does the woodlot need to be to qualify as a business? It should probably be big enough to require a "significant" portion of your available time. You might consider using the material participation requirements under the passive activity loss rules as a guideline, although this is clearly not one of the intended uses of these rules. If under the rules you are considered to be materially participating, then it is logical to conclude that the activity constitutes a business.