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Sub-Section 219, Long-Term Leases

Internal Revenue Manual
Specialized Industry Guidelines - Timber
Sub-Section 219, Long-Term Leases
Last amended: 6-26-1978

Long-Term Leases

(1) Long-term leases are those that are to remain in force long enough to allow planted or naturally regenerated seedlings to grow into a crop of timber, generally from 25 to 99 years. The provisions of the lease contracts will vary widely, but all provide for the lessee to have rights to use the land and cut the timber for the term of the lease.

(2) Usually, the land owner will receive periodic payments over the term of the lease and the contract will often have an escalator clause that provides for payments to be adjusted periodically according to the wholesale commodity price index or some other economic indicator.

(3) These transactions may be captioned as timber sales and the words "lease" or "rent" might not even be mentioned in the contract. The contract usually provides that the purchaser will cut and pay for a certain number of cords of pulpwood each year at a specified price or contain other provisions that seem to indicate the parties intend to buy and sell timber. The common thread woven through all these contracts is that the taxpayer landowner will be paid without regard to when the timber is cut or if it is cut at all.

(4) The tax treatment for long-term leases is outlined in Rev. Rul. 62-81, 1962-1 C.B. 153 and Rev. Rul. 62-82, 1962-1 C.B. 155. These rulings hold that the long-term leases actually accomplish a sale of timber and a lease of the land. The first dollars paid by the lessee are considered to be payment for the timber standing on the land as of the date of the lease. Once the sum of the payments equals the fair market value of the timber standing on the land on the date of the lease, additional amounts paid under the lease are ordinary deductions to the lessee, the ordinary income to the lessor.

(5) The difference between the landowner's adjusted basis in the timber on the date of the lease and the fair market value of the timber on the same date is the landowner's gain or loss on the sale of the timber. Whether the sale is a casual sale resulting in long-term capital gain will depend upon the facts and circumstances of each case.

(6) These long-term leases do not qualify under IRC 631(b) because the landowner will be paid whether the timber is cut or not and hence has not retained an "economic interest" in the timber. The transaction does not fall within the provisions of IRC 631(a) because the landowner does not cut his/her own timber.