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Settlement Guidelines for Computation of Timber Casualty Losses

October 25, 1995

COORDINATED ISSUE PAPER

STATEMENT OF ISSUES

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?

EXAMINATION DIVISION POSITION

The position set forth in Rev. Ruls. 66-9 and 73-51 remains 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 (also known as non-merchantable timber and immature timber growth), 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.

DISCUSSION

Background:

The focus of the problem with which we must deal on this issue is the definition of the term "single, identifiable property" regarding a casualty loss on timber property. As a simple example, assume that a taxpayer has a block of timber consisting of 200,000 acres of trees with a fair market value of $300,000,000 and a tax basis of $10,000,000. (See Treas. Reg. Section 1.611-3(d) for the meaning of a block). A casualty (fire, storm, etc.) occurs and destroys 20 percent of the trees in the block. The fair market value of the block after the fire is $240,000,000.

The taxpayer contends that the "single, identifiable property" is the entire 200,000-acre block. Under this assumption, the casualty loss deduction would be the lower of the basis ($10,000,000) or the decrease in the fair market value of the property ($60,000,000). Thus, under this assumption, the taxpayer would deduct its entire basis in the 200,000-acre block even though 80 percent of the trees remain undamaged.

The Government, of course, would argue that this position leaves the taxpayer with 80 percent of its trees undamaged and with no tax basis; therefore, the only logical definition of "single, identifiable property" is a unit which would limit the taxpayer's basis to the actual property destroyed. The Government, therefore, contends that the depletion unit should be used as the "single, identifiable property".

To further illustrate the problem, if we assume that I own 100 shares of stock and 50 of those shares are stolen, it goes without saying that my basis, for purposes of the theft loss computation, would be limited to 50 percent of my basis in the stock. On the other hand, if I own an automobile and a fender is damaged, I am not required to compute the basis of only the fender for purposes of the basis limitation in a casualty loss. The basis limitation would be defined as the basis of the entire car.

The difference in these two examples is the nature of the assets involved; one might think of a tract of timber as consisting of fungible units similar to shares of stock so that a per-tree allocation (or board foot) of basis would be appropriate. On the other hand, trees may be more interdependent than shares of stock, and, therefore, be similar to parts of a machine or automobile. Damage to some trees may damage others indirectly and this may suggest that the "property damaged" should be viewed as the whole tract. There are rulings and cases regarding this problem but the area is still unsettled.

Law and Argument:

IRC Section 165(b) states that the basis for determining the amount of the deduction under Section 165(a) is the adjusted basis provided in Section 1011 for determining the loss from the sale or other disposition of property.

Treas. Reg. Section 1.165-7(b)(1) states that the amount of loss to be taken into account for purposes of Section 165 is the lesser of either (1) the reduction in the fair market value of the property on account of the casualty, or (2) the amount of the adjusted basis prescribed in Treas. Reg. Section 1.1011-1. However, if property used in the trade or business or held for the production of income is totally destroyed and if the fair market value before the casualty is less than the taxpayer's adjusted basis in the property, the amount of the adjusted basis is treated as the amount of the loss. Treas. Reg. §1.165-7(b)(1)(ii).

Treas. Reg. Section 1.165-7(b)(2)(i) states that a loss incurred in a trade or business or in any transaction entered into for profit shall be determined under subparagraph (1) by reference to the "single, identifiable property" damaged or destroyed.

Treas. Reg. Section 1.611-3(c)(1) requires every taxpayer claiming a deduction for depletion of timber property to keep accurate ledger accounts recording the cost or other basis provided by Section 1012 of the property and the land together with subsequent capital additions and adjustments under Section 1016. Treas. Reg. Section 1.611-3(c)(2) states that, in such accounts there shall be set up separately the quantity of timber, the quantity of land, and the quantity of other resources, if any, and a proper part of the total cost or value shall be allocated to each after proper provision for immature timber growth under Treas. Reg. Section 1.611-3(d).

Treas. Reg. Section 1.611-3(d)(3) provides that the total value or total cost, as the case may be, of land and timber shall be equitably allocated to the timber and land accounts respectively, and that in cases in which immature timber growth is a factor, a reasonable portion of the total value or cost shall be allocated to such immature timber.

Rev. Rul. 66-9, 1966-1 C.B. 39, concludes that in the case of destruction of timber by a casualty, the "single, identifiable property" for purposes of Treas. Reg. Section 1.165-7(b)(2)(i) is the board foot or cord and that the amount allowable as a casualty loss deduction is limited to the adjusted basis for determining the loss from the sale or other disposition of the quantity of timber that was rendered unfit for use by the casualty. Adjusted basis on sale or other disposition of timber is determined by reference to Sections 611 and 612.

In Harper v. United States, 274 F. Supp. 809 (D.S.C. 1967) [67-2 USTC ¶9712], aff'd per curiam, 396 F.2d 3[2]23 (4th Cir. 1968) [68-2 USTC ¶9441], the court accepted the Service's position that the board foot or cord of timber in merchantable trees is the "single, identifiable property" for purposes of Treas. Reg. Section 1.165-7(b)(2)(i).

In Rosenthal v. Commissioner, 48 T.C. 515 (1967) [CCH Dec. 28,533], aff'd, 416 F.2d 491 (2d Cir. 1969) [69-1 USTC ¶9430], the Tax Court and the Second Circuit also agreed with the Service that a casualty loss deduction for timber destroyed is limited to the taxpayer's basis in the units of timber destroyed.

In Rev. Rul. 73-51, 1973-1 C.B. 75, the Service concluded that a taxpayer could not take a casualty loss deduction for damage to surviving merchantable trees that did not currently decrease the amount of units of timber but that might retard subsequent growth of the trees. Citing Rev. Rul. 66-9, Rosenthal and Harper, the revenue ruling indicates that the "single, identifiable property" destroyed is the quantity of timber rendered unfit for use by the casualty.

However, in Westvaco Corp. v. United States, 639 F.2d 700 (Ct.Cl. 1980) [81-1 USTC ¶9101], the Court of Claims disagreed with the views of the Second and Fourth Circuits and held that the block or district is the "single, identifiable property" for purposes of the adjusted basis limitation of Treas. Reg. Section 1.165-7(b)(2). The Court concluded that the manner in which basis is determined for depletion purposes should not dictate how it is determined for casualty loss purposes, and that all timber, both merchantable and nonmerchantable as stipulated in the case, in a single block or district should be seen as the "single, identifiable property" for purposes of the regulation.

In Weyerhaeuser v. United States, 32 Fed. Cl. 80 (1994) 94-2, USTC 50471, the Court of Federal Claims heard essentially the same question as presented in Westvaco, but held for the government. In both Westvaco and Weyerhaeuser (Weyco) the taxpayer wanted the single, identifiable property (SIP) to be defined as the entire block; the Government wanted the SIP defined as the depletion unit (board foot) in Westvaco and as the timber stand in Weyerhaeuser.

In Weyerhaeuser, the issue involved 319 separate forest fires and the eruption of Mt. St. Helens. In all incidences the taxpayer claimed that the SIP was the block in which the casualty occurred. As to the eruption in 1980, Weyerhaeuser's Mt. St. Helens tree farm, consisting of 472,000 acres of timber, was treated as one block for depletion purposes.

Although the destruction caused by the Mt. St. Helens eruption was pervasive, timber on only 68,000 acres was affected. Using the lesser of the decrease in fair market value of the 472,000 acres of trees or the basis in those trees, Weyerhaeuser Company claimed, as a casualty loss the entire basis of its trees on the 472,000 acres.

The Examination Division limited the deduction to the depletion basis of the depletable timber destroyed, plus the basis in the acres of reproduction destroyed on the 68,000 acres, and Weyerhaeuser filed suit in the Court of Federal Claims.

The position taken by the Government in Weyerhaeuser was that the "single, identifiable property" was a unit smaller than the block, but larger than the depletion unit (board foot or cord), or the acre in the case of young growth.

The Government contended in Weyerhaeuser that the "single, identifiable property" was the "stand". A "stand" is an aggregation of trees sufficiently uniform in composition to be distinguishable from the tree growth on adjoining areas.

In Weyerhaeuser, the court distinguished the situation from that in Westvaco by explaining that in Westvaco the court could only choose between the board foot (which it found unacceptable) and the block. The court in Weyerhaeuser, however, had a choice between the block and the stand, and found the stand more acceptable. The Weyerhaeuser court went to some length to explain that it followed the rationale of Westvaco, but that it had different facts on which to apply the rationale. The court noted that determining SIP is a factual matter, at least in part, that is dependent on the particular facts of a case.

The Weyerhaeuser court found that although Weyco managed its timberlands by Region (Block), Weyco's peculiar management style was not dispositive of the SIP. Evidence showed that the basic identification concept by which Weyco identifies and accounts for its timber is the timber stand, which is the bedrock of Weyco's timber "inventory" system. The court found the smaller management unit, by which there was a physical separability of property, more appealing as the SIP rather than the block since it would result in far less "basis borrowing" from unharmed property.

The general principles guiding the Weyerhaeuser court in determining the SIP are--

"[A] taxpayer may not borrow basis from his unharmed property in order to increase the amount of his deduction for an injury to his "[damaged]" property.' Rosenthal, 416 F.2d at 497-98 [69-1 USTC ¶9430],"

"The rationale for construing narrowly the noun 'property' [in reference to the single, identifiable property damaged or destroyed in Treas. Reg. Section 1.165-7(b)(2)(i)], so that the asset affected is defined in terms of the least common denominator involved in the casualty, is that 'the identity of "the property", the loss of which will generate the deduction, must be reasonable in relation to the loss.' Westvaco, 639 F.2d at 708 [81-1 USTC ¶9101]," and

"What constitutes the single identifiable property ('the SIP') damaged or destroyed in any particular casualty event, of course, is necessarily a question of fact. See Westvaco, 639 F.2d at 704, 720 [81-1 USTC ¶9101] (stating that to determine what the SIP is, 'it is necessary to consider the nature and extent of timber damaged ... [i.e., the facts of the case]'); Rosenthal, 416 F.2d at 498, 500 [69-1 USTC ¶9430] (finding that the amount of a casualty loss shall be determined solely with reference to the property destroyed). (Footnote omitted).

Weyerhaeuser, 32 Fed. Cl. at 100 [94-2 USTC ¶50,471].