Sub-Section 143, Allocation of Basis
Internal Revenue Manual
Specialized Industry Guidelines - Timber
Sub-Section 143, Allocation of Basis
Last amended: 6-26-1978
Allocation of Basis
(1) When timber property is acquired, the cost or other basis must be allocated between the land, the merchantable timber, the immature timber, depreciable property, and improvements. Since the cost of each of these components is treated differently for tax purposes, the allocation must be reasonable and equitable.
(2) You may find, high values placed on depreciable assets, high values allocated to merchantable timber for recovery through allowance for depletion, and low values placed on land which is neither depreciable nor depletable.
(3) The objective should be to allocate a fair and equitable portion of the total cost to each asset acquired. The general rule of allocation is stated in the regulations regarding the apportionment of lump sum cost between depreciable and nondepreciable property. It provides that the basis of a given class of assets must bear the same proportion to the lump sum as the value of that class at the time of acquisition bears to the value of the entire property at that time. This general rule has been restated by the courts to the effect that if a total consideration is paid for a mixed aggregate of assets, its allocation among the various properties should be based upon the relative value of each item to the value of the whole. Allocation based upon the relation of the fair market value of each asset to the total fair market value of all the assets is equitable and automatically makes allowance for premium prices paid and for bargain purchases.
(4) The first step in applying the general rule to an allocation problem would be to determine the fair market value of each asset or group of assets on the acquisition date. Standard appraisal methods should be used giving due weight to all the factors which influence value. The proportion of the total value represented by the value of each asset is then determined and a proportionate part of the total cost is allocated to each.
(5) This all sounds relatively simple but it is not so easy in actual practice. The determination of fair market value is not an exact science. Fair market value is largely an expert opinion based upon experience after weighing all the relevant facts and tempering with reason and judgment.