How to Establish and Change Timber Accounts
Tree Farmer Magazine: July/August 2006 - Volume 25 No. 4
I've mentioned in the last several columns the need to evaluate how your timber accounts are set up because of changes in the way casualty losses are treated and the deduction for qualified reforestation expenses. This column will attempt to make sense of the rules and how they may apply to you. You should fall into one of two basic categories: (1) You've already set up your accounts and want to evaluate if they need to be changed, or (2) You haven't set them up yet and want to do so in the best way possible. I'll use a question and answer format.
What's the relevant change in the casualty loss rules? Previously the "property" destroyed was each unit volume, e.g. cord or MBF. Now the "property" is the "block." Since the adjusted basis of the block is bigger than that of a single unit of volume, using the block may result in a larger deductible loss. But, as before the maximum loss deduction possible is the adjusted basis of the block. Thus, if you are in a hurricane zone having your timber in one block may be beneficial.
What's a block? The primary considerations in determining what constitutes a block are timber valuation factors. Historically all the timber that would logically be sold to the same point of manufacture was critical, but in most regions there are now many possible markets. A block can be all the timber that would be harvested in a single logging unit. Geographical or political boundaries are also valid criteria. Logical management units can also be used to define blocks.
How's a block related to an account? All the timber in a block is contained in one account. Anytime any timber is disposed of and a depletion allowance claimed, the adjusted basis and volume for the block is used. This is sometimes called "average depletion." But, it is possible to have multiple accounts, called subaccounts, for a given block. There are in fact required subaccounts, discussed below.
What if I'm not in a hurricane zone? If the after-tax rate of return on your tree farm investment is important to you, then you would want to set up your accounts to recover your basis in the timber as soon as possible. This means setting up accounts according to anticipated timing of harvests, requiring either multiple blocks or multiple subaccounts for a given block. This is generally consistent with the underlying principle of tying accounts to the valuation process used to establish the original basis of your timber.
You almost make it sound like I can set up my accounts any way I want? This can't be true? And of course it isn't, but keeping things in perspective is helpful. An auditor's biggest concern will be how you established the total original basis of your timber. This is the maximum amount you can recover regardless of how your accounts are set up. For details visit www.timbertax.org
When are my timber accounts and resulting depletion deductions considered to be "approved" by the IRS? The only circumstance under which you can consider your timber accounts to be approved by the IRS is if you're audited and you're not required to change your accounts. Thus, a majority of tree farmers will never have their accounts "approved."
What about the implications of the relatively new reforestation deduction and continuing amortization? Recall that the $10,000 per year reforestation expense limit applies to each qualified timber property (QTP). If you're audited you need to be able to show on your maps and in your accounts detailed records for each individual reforestation project. This is not a real change since so-called deferred reforestation (plantation) subaccounts have always been required. If more than $10,000 is expended for a given QTP, the overage goes into an amortization account.