• Home
• Federal Income Taxes
• State Tax Laws
• Estate Planning
• Publications
  • Ag. Handbook #731
  • Internal Revenue service
  • Tax Articles
  • Historical Documents
  • Forest Service Publications
• Professional Research
• Tax Workshops/Education
• Tax Policy
• Links

Computation of Timber Casualty Losses

October 31, 1991

ISSUE

When timber is damaged or destroyed in a qualifying casualty loss, what is the "single, identifiable property" for purposes of computing the basis limitation? Is it the marketable units of affected timber (i.e., board feet or cords) or the entire timber tract.

BACKGROUND, LAW, AND ANALYSIS

Section 1.165-7(b)(1) of the regulations provides that in the case of a casualty loss, the amount of loss is the lesser of (1) the difference between the fair market value of property immediately before and immediately after the casualty, or (2) the adjusted basis of the property prescribed in section 1.1011-1 of the regulations for determining loss from sale or other disposition. However, if property used in a trade or business or held for the production of income is totally destroyed and its fair market value was less than its adjusted basis immediately before the casualty, the amount of adjusted basis is treated as the amount of the loss.

Section 1.165-7(b)(2)(i) of the regulations provides that in the case of a loss incurred in a trade or business or a transaction entered into for profit, the amount of loss shall be determined under section 1.165-7(b)(1) by reference to "the single, identifiable property damaged or destroyed."

Section 1.612-1(a) of the regulations provides that the basis upon which the deduction for cost depletion under section 611 of the Code is to be allowed in respect of any timber property is the adjusted basis provided in section 1011.

Section 611 of the Code provides for a deduction for depletion based, in the case of timber, on its adjusted basis under sections 612 and 1011.

Section 1.611-3(c) of the regulations requires every taxpayer claiming or expecting to claim a deduction for depletion of timber property, to establish accounts in which to record the basis provided by section 1012 in the timber and land.

Section 1.611-3(e) of the regulations requires the taxpayer to estimate as nearly as possible with respect to each separate account, the total units (feet board measure, log scale, cords, or other units) of timber available for use at the time of acquisition. This estimate must be revised when necessary to account for growth, losses, and other factors.

Section 1.611-3(b) of the regulations provides for the calculation of a "depletion unit" by dividing the adjusted basis of the timber in an account by the number of units in the account as determined under section 1.611-3(e). The depletion unit is then used to determine the amount of basis allocable to timber cut during the year.

Section 1.611-3(d) of the regulations describes how timber and land may be aggregated in establishing the accounts required by section 1.611-3(c). In general, each such account includes all of the timber located in one "block." A block may be an operation unit or a logging unit, or may be established by geographical or political boundaries or logical management areas.

In Rev. Rul. 66-9, 1966-1 C.B. 39, a hurricane destroyed or damaged some of the timber on five different tracts of the taxpayer's land. Some of the damaged timber was salvaged and some was unfit for salvage. The ruling holds that in the case of a casualty loss to timber, the "property involved" and the "single, identifiable property destroyed" for the purpose of determining the amount of the deduction under section 1.165-7(b) of the regulations is the quantity of timber that is rendered unfit for use by reason of the casualty. The ruling also holds that timber that may be salvaged is not "destroyed." Accordingly, the amount allowable as a casualty loss is the taxpayer's adjusted unit basis under section 1011 of the Code multiplied by the number of units of timber found to be unfit for use.

In Harper v. United States, 396 F.2d 223 (4th Cir. 1968) [68-2 USTC ¶9441], affirming per curiam 274 F. Supp. 809 (D. SC 1967) [67-2 USTC ¶9712], the taxpayers, in order to determine the amount of a loss from hurricane damage, multiplied the units of merchantable timber destroyed by the value of a unit. The court agreed with the position of the Service that the amount of the deduction was limited to the taxpayers' allocable basis in the units destroyed, not their basis in all the timber on the tracts affected by the hurricane.

In Rosenthal v. Commissioner, 416 F.2d 491 (2d Cir. 1969) [69-1 USTC ¶9430], affirming 48 T.C. 515 (1967) [CCH Dec. 28,533], an ice storm caused damage to plantations, naturally produced young growth, merchantable pulpwood, and merchantable sawtimber on the taxpayer's timber tract. The Service allowed a deduction for the loss to the immature timber on the plantations, in which the taxpayers had basis, but disallowed the deduction claimed for damage to naturally regenerated young growth, to which the taxpayers had allocated no basis. With respect to the merchantable pulpwood and sawtimber, the Service rejected the taxpayers' claimed loss, which was calculated by reference to their basis in all the timber on the tract. The Service allowed a deduction only to the extent of the taxpayers' basis in damaged trees, allocated according to the depletion units in those trees, on the grounds that individual trees were the "single, identifiable properties" damaged or destroyed. The Tax Court and the Court of Appeals for the Second Circuit held for the Service.

In Rev. Rul. 73-51, 1973-1 C.B. 75, an ice storm struck portions of the taxpayer's timber tract, causing physical damage to trees containing merchantable timber. There was no damage measurable in units of timber destroyed. However, the taxpayer claimed a loss based on broken tops or limbs, root damage, and leaning or bending of trees, on the basis that these injuries would reduce the rate or quality of subsequent growth, or render the trees susceptible to insects and disease. The taxpayer calculated the amount of the deduction by discounting projected economic losses based on estimates of the number of units of timber that would not exist or would be downgraded in quality at the time of future harvest as a result of the injuries. The ruling holds that no deductible loss occurred because none of the merchantable timber in the trees was damaged or rendered unfit for use, and any loss resulting from the injuries to surviving trees was in the nature of a loss of future profits or potential income.

In Westvaco v. United States, 639 F.2d 700 (1980) [81-1 USTC ¶9101], the taxpayer's timberlands incurred damage as a result of a series of storms and fires. The taxpayer claimed casualty losses based both on "mortal injuries"--injuries that destroyed the timber or rendered it economically unsalvageable--and "nonfatal injuries"--injuries similar to those considered in Rev. Rul. 73-51. The taxpayer claimed losses for both types of injuries calculated under section 1.165-7(b) by reference to its basis in all the timber in the affected "woodlands." As alternatives, it calculated the losses by reference to its basis in all the timber in each tax depletion district (i.e., in each depletion account) within each woodland, and by reference to its allocable basis in the trees within each account that were actually damaged or destroyed. The Service, following Rev. Rul. 66-9 and Rev. Rul. 73-51, allowed no deduction for "nonfatal injuries" and computed the deduction for "mortal injuries" using the taxpayer's adjusted depletion basis in merchantable units actually destroyed or rendered unsalvageable.

The Court of Claims in the Westvaco case held that there is no bar as a matter of law to the recognition of a partial loss to timber stemming from damage not measurable in units of merchantable timber totally destroyed, if such claims can be measured with an accuracy sufficient to prevent the taxpayer from gaining a tax benefit from mere paper losses or anticipated future income, or losses of property for which it has no basis.

With respect to the property unit to be used to determine the decline in value and the allocable basis under section 1.165-7(b) of the regulations, the court held that the "single, identifiable property" damaged by a casualty to timber is all of the standing timber, merchantable and non-merchantable, in an affected area. Based on the definition of "property" in section 1.611-1(d) of the depletion regulations, the court found that the relevant area for Westvaco was each district established by the taxpayer as a separate depletion account for Federal income tax purposes.

SERVICE POSITION

(1) The position set forth in Rev. Ruls. 66-9 and 73-51 remain the official position of the Service, notwithstanding any court case decided contrary to that position. Thus, the amount of casualty loss in the case of merchantable timber is limited to the quantity of timber rendered unfit for use multiplied by the adjusted unit basis (the depletion unit for taxpayers that claim timber depletion). In the case of young growth (non-merchantable timber), an acre of young growth, which is the common unit used in the dispositions of young growth with the associated land, in most instances should be the basis for determining the amount of the loss.

(2) Cases involving timber casualty losses should be brought to the attention of the Forest Products Industry Specialist immediately upon discovery. This will ensure coordination of the issue, on which there is a high probability of litigation.