Handling Fire Losses and Reforestation Expenses of Trusts
Tree Farmer Magazine: July/August 2007 - Volume 26 No. 4
This column deals with two current issues. First, if your timber has been burned by the devastating fires in the southeast, there are actions you should take as soon as possible. Second, if your Tree Farm is titled to a trust, there's an issue regarding how reforestation expenses are treated.
Casualty Loss from Forest Fires
Forest fires result in casualty losses with many tax implications. After dealing with any timber account issues, you'll need the forester's help to determine the fair-market value of your timber before and after the fire. Make certain that he or she does this for all the timber, even the unburned timber, included in each timber account. Under the "new" rules it's likely that the land covered by each of your timber accounts will be the single identifiable property, so-called SIP.
For SIP, your loss, if any, will be determined by claiming the lesser of the basis of the SIP and the decrease in the fair-market value of the timber in the SIP. You'll need to deal with the issue of claiming a loss for timber damaged but not destroyed. Ask you consulting forester to clearly record the volume and value of timber destroyed, and the volume damaged and how the damage value was estimated.
You'll also need to work with your consultant to determine the potential for salvaging timber that is damaged but not rendered un-merchantable. Given current poor markets and the fact that charred timber has little if any value as pulpwood, you may conclude that there is no reason to put the timber up for sale. The safest approach is to attempt to sell and, if you get no offers, you'll have proof of lack of merchantability. Remember that you may want to include unburned timber in a sale to restore management units to a uniform condition.
Income from salvage sales is taxable, and treated like any other timber sales, except that it's reported on Form 4797 as an involuntary conversion. Also, you can postpone the tax on this income by buying qualified replacement property. If you want to do this, start planning now with you accountant and forester.
Reforestation Expenses of Trusts
All taxpayers except trusts may deduct up to $10,000 per year of qualified expenses for each qualified timber property, so-called QTP (Code Sec. 194(b)(1)(B) (iii)). An unlimited amount over $10,000 can be amortized as under prior law. Trusts can amortize, but there's a caveat in IRS publications and advice to taxpayers. Trusts can be very complicated for tax purposes and the issue is how the amortization deduction should be allocated among the trust itself and the beneficiaries. Congress made clear its intent, but included instructions to the IRS to deal with the complications through regulations. The issuance of temporary regulations, the first step in the process, may take several years. Affected trust have two choices: (1) don't claim the amortization deduction, but instead capitalized the cost to a deferred reforestation account, or (2) work with their legal advisors to develop an interpretation of how regulations for Code Sec. 194(c)(4) are most likely going to treat their tax situation, and file based on this defensible position. If the regulations go against the position taken, an amended return can be filed. What might the regulations specify?
Obviously, they will say that the amortizable amount can't be claimed on more than one tax return. Treatment for grantor trusts would also seem obvious. These are trusts for which the person establishing the trust, the grantor, retains almost complete control of the trust's assets, and what is done with the benefits, including income and deductions. Grantor trusts are generally ignored for income tax purposes and all transactions of the trust are included on the tax return of the grantor. If, however, the trustee can allocate income and deductions among the tax returns of the trust itself and the beneficiaries, more interpretation of existing law is needed.
Assistance from qualified legal counsel is critical for trusts that claim an amortization deduction before regulations are issued.