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Act Now to Reduce 2000 Bill - Tree Farmer Magazine

Tree Farmer Magazine: September/October 2000 - Volume 19, No. 5

Your annual tree farm income probably varies. Your expenses, however, are likely to be more consistent. As the 2000 tax year comes to a close your tax advisor may suggest you adjust expenses to match your income. The purpose may be to show a profit in 2000. Even though most tree farmers can't meet the presumptive test of the hobby loss rule it's good to report a profit as often as possible. More likely the purpose will be to offset income.

Cash Basis or Accrual

If you report items of income/expenses in the year received/paid you are a cash basis taxpayer. This gives you more flexibility than under the accrual accounting system. An accrual system requires reporting in the year the right/obligation is incurred, regardless of when income is received or payments made. Either way the IRS prefers consistency in your year-to-year treatment of incomes and expenses. For example, prepaying or postponing regularly recurring expenses such as property taxes and insurance premiums may be disallowed under an audit. Other expenses are discretionary and provide greater planning options. The purchase of equipment in a year you've received timber income is the most frequent tactic I hear about.

Recovering Cost of Equipment

The cost of major items of equipment is recovered by depreciation or by electing to deduct it under section 179 of the Internal Revenue Code (section 179 deduction). Depreciation involves deducting the allowable amount annually for a specified period, most likely 5 years for equipment such as a tractor used for thinning, timber stand improvements, harvesting, road and fire lane maintenance, or similar ordinary and necessary activities. If, however, the equipment is used for the construction of capital improvements or the planting of trees the applicable proportion of depreciation must be capitalized to the appropriate capital account.

If the equipment is also used for personal use you won't be able to recover any of the cost unless it's used less than 50 percent for personal use. If used more than 50 percent for business or the production of income you must reduce the deduction otherwise allowed. For example, if your tractor is used 20 percent of the total hours operated to mow the lawn for your residence, you'd qualify for only 80 percent of the depreciation or section 179 deduction otherwise allowed.

Investment Activity. Activities conducted for the production of income as an investment don't qualify for the Sec. 179 deduction. Thus, accelerating the purchase of equipment will not provide as big a tax benefit in 2000. Your 2000 deduction will be limited by the depreciation rules. For example, if you purchase a tractor in the fourth quarter the mid quarter convention will apply and your 2000 depreciation deduction will be only 12.5 percent of the total first year depreciation otherwise allowed. If you used the 200 percent declining balance method the depreciation percentages for years 1 to 6 would be 5, 38, 22.8, 13.68 10.94, and 9.58 respectively.

Business Activity. As a business you may qualify to deduct up to $19,000 of equipment expenses for 2000. There is no reduction if you make the purchase at the end of the year. The limit will be $24,000 in 2001 and 2002, and $25,000 after 2002. The limit applies at the business and the owner level. For example, the $19,000 limit applies to a partnership and each partner, or to an S corporation and each stockholder. Note that trusts and estates don't qualify for this deduction.

There is also a taxable income limit. For example, if your total taxable income from the business is less than $19,000 your Sec. 179 deduction would be limited to this lesser amount. Taxable income for this purpose includes Section 1231 gains. Thus, timber income reported under Sec. 631(b), disposals with an economic interest retained, or Sec. 631(a), election to treat a cutting as a sale, are included.

There is also a limit based on the total investment in qualifying Sec. 179 property. The deduction is reduced for amounts over $200,000. For example, if you invested $201,000 your deduction would be $18,000. If you invested $219,000 or more you would have no section 179 deduction.

If the equipment is taken out of business use or disposed of you'll need to recapture a portion of the section 179 deduction. The recapture is determined by comparing the deduction taken with that allowed under depreciation rules.

More Information

IRS Publication 946, How to Depreciate Property, has all the details and is available on the National Timber Tax Website.

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)