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Do Your Timber Accounts Reflect Reality?

Tree Farmer Magazine: March/April 2000 - Volume 19, No. 2

The importance of establishing the basis (book value) of your timber can't be stressed enough. It's used to recover your investment when timber is sold, or is subject to damage, destruction, theft, or exchange. It also becomes the basis in the hands of the recipient if you give it to someone. How you account for your basis can have a big impact on your tree farm's "bottom line."

Timber Accounting Basics

Let's first review the basic timber accounts and how they're established.

Allocation of Basis

The main issue I've focused on in the past is allocation of the total basis among the land, merchantable timber, young growth, and other assets acquired. Allocation is done according to the proportion of total fair market value represented by each asset. For example, assume you buy a tract for $90,000. An appraisal, however, determines that the tract contains 200 thousand board feet (MBF) of timber with a fair market of $60,000. The appraisal determines that the fair market value of the land is $40,000. This makes the total fair market value $100,000 – 60% for timber and 40% for land. The basis of the timber would be $54,000 (0.60 x $90,000) and the basis of the land would be $36,000. If you negotiated separate sale prices for the land and timber, and actually paid these amounts, these prices would be used as the original separate bases for the land and for the timber.

Parts of Timber Account

Each timber account has two parts: dollars and volume. The original cost or other basis, $54,000 in the example, is entered at the time of acquisition and increased for costs capitalized to the timber and decreased by depletion when you harvest timber, or by allowable basis when you sell stumpage. The volume part of the account is increased for growth and decreased for harvests and losses.

How Many Accounts?

Let's now consider how many timber accounts you should have. Should it all be in one account ("average depletion") or in several separate accounts ("block depletion")? The regulations (Internal Revenue Code Regulations Section 611-3) give timber owners a great amount of flexibility in establishing timber accounts. There should, however, be some operational or marketing rationale for the system established. That's what separates tax evasion from tax management.

Whether you use "average depletion" or "block depletion" may significantly affect how fast you recover your basis -- your investment in the timber.

Average Depletion

Most tree farmers use average depletion. This means all their merchantable timber is in one account. It greatly simplifies things. In particular you have to make only one growth estimate when you adjust the volume part of your account. It also tends to be best if you have plantation or young growth accounts that will be transferred to the merchantable timber account. This spreads "new dollars" across all your merchantable timber.

It may not, however, maximize the after-tax return on your investment. You should consider the advantages of having multiple accounts.

Block Depletion

The basic timber accounting unit is referred to as a "block." This is a designated area of timberland logically treated as a single unit. Average depletion means all your timber is in one block. The designation of blocks is usually based on physical location. For example, if you own several parcels of widely scattered timberland each of which is managed separately, it might be logical to treat each as a separate block. Blocks can also be based on timber product grown, harvesting units, or other operational or economical criteria.

Block subaccounts. The regulations also allow you to establish subaccounts within a block. For example, if the timber within a block varies in value and will be sold into separate markets it might be logical to have one subaccount each for pole timber, sawtimber, veneer timber, and any other category that would be marketed separately, or at different points in time. It might also be logical to have separate subaccounts for high valued and low valued species typical of hardwood stands.

A goal might be to establish subaccounts to balance the proportion of basis recovered with the proportion of the value of the block sold over a given period of time. For example, if you buy uneven-aged stands and plan on releasing crop trees by harvesting mature trees, you could allocate a larger portion of the available basis to the trees to be harvested initially, and less to the lower value smaller trees to be harvested in the future.

Can You Change Your System?

The preferred time to make these decisions is when you initially establish your accounts. You can, however, make changes later. Keep in mind that all you can do is reallocate your current basis across a different set of accounts. You can't increase your total basis.

If after careful analysis you decide to make changes you'll need to file Form 3115, "Application For Change In Accounting Method." Don't be intimidated by the form. Unless you're under audit or in court you'll check "No" six times in Part I and move on Parts II – IV where you actually explain your changes. You'll need to justify you changes. For many of you the justification is so your accounts will better reflect how your timber is managed and so that the basis can be recovered in proportion to the value of timber disposed of.

Don't loose sleep over this. My job is to give you something to think about. We teach are students that doing nothing is frequently the right decision, unless you're a politician.

The following article has been reproduced here from the "Tree Farmer" magazine with the permission of the American Forest Foundation, 1111 19th Street, N.W., Suite 780, Washington, D.C. 20036. (Telephone 202.463.2462)