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Rev. Rul. 62-82 1, 1962-1 CB 155

REV-RUL, SECTION 1221.--CAPITAL ASSET DEFINED, Rev. Rul. 62-82 1, 1962-1 CB 155, (Jan. 01, 1962)

SECTION 1221.--CAPITAL ASSET DEFINED
(Also Section 631, 1231; 1.631-1, 1.1231-1.)

Lump sum payment under a contract for the lease of land and the grant of the right to cut timber therefrom constitutes proceeds of the sale of timber to the extent of the fair market value of the timber then existing; the resulting gain or loss is subject to the treatment described in subchapter P of the Internal Revenue Code of 1954, provided the provisions thereof are met. Any excess of such payments over the fair market value of the existing timber is ordinary income.

Advice has been requested as to the treatment for Federal income tax purposes of income received by an owner, or lessor, pursuant to a long-term contract under the circumstances described below.

In the case under consideration, the owner (taxpayer) of timberland, in consideration of 2x dollars per acre per year or a total of 198x dollars (received in a lump sum upon the execution of the contract), leased, let and rented to a paper company for 99 years the surface rights, the rights of future operation and the right to cut and remove any and all timber, trees, wood and other forest products standing, growing or being situated and to be situated during the life of the contract on the described land.

The taxpayer retained ownership of all mineral rights and remained liable for taxes on such retained rights. The paper company was obligated to pay all taxes assessed against the leased property, including severance tax on the timber. The paper company may relieve itself of future liability for taxes with respect to such acreage as it may designate, but there is no provision for the rebate under such circumstances of any of the consideration originally paid for the use of such acreage.

The paper company has the exclusive right to recover for damages to the timber caused by mineral operations of the taxpayer or his lessees. The paper company is reimbursed for any land used in sand and gravel operations at a specified rate and for any damage to timber from such operation.

The taxpayer warrants title to the property, including timber thereon. In the event of loss of title by the taxpayer, or loss of possession by the paper company, the taxpayer will refund to the paper company the original consideration paid per acre for the lands so affected. The paper company has the right to recover and keep any awards, or damage payments resulting from trespasses or from condemnation of the property for public use, with respect to the value of the timber and the value of its rights with reference to future operations under the contract.

For reasons more fully set forth in Revenue Ruling 62-81, page 153, there has been under this contract, no "disposal" of timber within the meaning of section 631(b) of the Internal Revenue Code of 1954.

The question remains whether any portion of the lump-sum payment under the instant contract is consideration for a transfer of property in a transaction amounting to a present sale of timber. The transaction could properly be such only if some portion of the consideration was paid for timber having, at the time of the execution of the contract, a determinable fair market value (merchantable timber of cutting size and smaller young growth of appraisable value). Timber that is not in existence at the time of the contract cannot be the subject of a present sale. See Williston on Sales (Rev'd Ed.), sections 62 and 258.

The rights and privileges conferred upon the paper company comprehended both the possession of land and the disposition of timber. There is no provision of the contract which relates any portion of the payment specifically to timber. Despite the absence of such a reference, however, some portion of the payment received by the landowner may, in fact, be attributable to timber. This would be true if the timber existing on the tract at the execution of the contract possessed a determinable fair market value. If the taxpayer establishes the fair market value of such existing timber, the payment to the extent of such fair market value constitutes proceeds from the sale of timber. The portion of the payment in excess of the value so established is in the nature of consideration for the use of land over a period of time and, therefore, ordinary income.

The position here is consistent with the conclusion by the Tax Court of the United States in Estate of James M. Lawton v. Commissioner, 33 T.C. 47 (1959), dealing with the tax treatment of receipts under a lease agreement. In that case, capital gain treatment had been allowed by the Commissioner of Internal Revenue with respect to receipts by the taxpayer, the landowner, for a described quantity of existing timber. The controversy related to succeeding receipts by the taxpayer which, from the evidence before the court, could not be identified as attributable to timber existing at the execution of the lease contract. The court held that such succeeding receipts were ordinary income to the landowner, describing these receipts as "in the nature of rent for the right to use and occupy acreage for 'pine tree farming' and other independent forestry activities." In the instant case, the taxpayer may establish that there was an existing stand of timber to which a determinable portion of the consideration could be attributed.

Accordingly, it is held that the lump sum payment received under the instant contract constitutes proceeds from the sale of timber to the extent of the fair market value of the timber existing at the execution of the contract; that the resulting gain or loss is subject to the treatment described in Subchapter P of the Code, provided the provisions thereof are met; and that any excess of the payment over the amount of such fair market value is ordinary income.