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Rev. Rul. 75-306, 1975-2 CB 243

REV-RUL, Timber cutting contract; road credit., Rev. Rul. 75-306, 1975-2 CB 243, (Jan. 01, 1975)

Section 631.--Gain or Loss in the Case of Timber, Coal, or Domestic Iron Ore

26 CFR 1.631-2: Gain or loss upon the disposal of timber under cutting contract.

[IRS Headnote] Timber cutting contract; road credit.--
The amount subject to treatment under section 631(b) of the Code by a corporate timberland owner that disposes of timber under a cutting contract that specifies the unit price for an estimated number of units and the amount of a road credit allowed the purchaser for building access roads is the actual amount realized, which is the total contract price reduced by the road credit.

Advice has been requested as to the treatment of amounts designated as road credits under the terms of a certain timber cutting contract that effects a disposal of timber with an economic interest retained within the purview of section 631(b) of the Internal Revenue Code of 1954, under the circumstances described below.

X corporation is a timberland owner that manages its timberland on a sustained yield basis and disposes of the timber under a cutting contract with Y corporation, the purchaser of the timber. The contract sets forth the estimated quantities of included timber and provides that all timber shall be paid for as cut at stated contract rates. The contract rates are those bid by Y. The total contract price, the number of units of included timber times the contract rate, takes into account, by the allowance of a road credit, the estimated cost of constructing certain specified roads on X's land necessary for the harvesting and removal of the timber by Y. X grants road credits to insure that the building of roads does not result in permanent damage to its timberland.

Y receives road credit for constructing roads in accordance with the specifications in the contract. The total amount of the road credit available to Y is stated in the contract, and is equal to the estimated total cost of constructing the specified roads. Y may not, without X's written consent, use the roads for the removal of timber until construction of such roads is substantially completed.

The following illustrates the manner in which the road credit is offset against the amounts payable under the contract. X disposed of an estimated 5,000 units of timber under a 2-year cutting contract. The contract rate is $30 per unit. Thus, the total contract price is estimated to be $150,000. Y's total required payment to X may be reduced by $25,000 in road credit for construction of the roads in accordance with the contract specifications. Y constructs the specified roads, earns the road credit of $25,000, cuts all the timber subject to the contract, and removes the timber over the roads. The total quantity of timber actually cut and removed amounts to 4,500 units. Y pays $110,000 (4,500 times $30, minus the $25,000 road credit).

Section 631(b) of the Code provides, in pertinent part, that the difference between the amounts realized from disposal of timber in any taxable year and the
adjusted basis for depletion thereof shall be considered to be a gain or loss upon the sale of such timber for such year.

United States v. Regan, 410 F.2d 744 (9th Cir. 1969), cert. denied, 396 U.S. 834 (1969), and Casey v. United States, 459 F.2d 495 (Ct. Cl. 1972), both involved the proper treatment to be given the cost of access roads incurred by the grantor of cutting contracts on the timberland involved. The taxpayers in each case had amortized the cost of the roads on the basis of the quantity of timber disposed of and had taken deductions therefor as ordinary and necessary business expenses. In disallowing these deductions, the court in each case concluded that section 631(b) of the Code requires all capital expenses to be included in the adjusted depletion basis in the timber. Each court also concluded that the cost of the access roads was a capital expense because commercial exploitation of the timber would not have been possible without the construction of the roads. It was determined that the roads were directly related to the acquisition and disposal of the timber. In each case, the court accordingly held that the expenses incurred in constructing the roads should be offset against the capital gains realized upon the disposition of the timber.

In the instant case, like Regan and Casey, the specified roads subject to the road credit were necessary for the commercial exploitation of the timber covered under the timber cutting contract. Because of the granting of the road credit by X, this case is analogous to Regan and Casey since the effect of the credit is the same as if the grantor of the timber cutting rights had reduced the contract price to reflect the cost of the roads. Therefore, the cost of those roads are directly related to the acquisition and disposition of the timber covered under the timber cutting contract.

Accordingly, in the instant case, the amount realized by the timber owner, X, for the timber included under the timber cutting contract subject to treatment under section 631(b) of the Code is $110,000, and does not include any amount designated as road credit since this amount is an adjustment of the price to reflect the value of the timber without access by road and the additional cost to the logger of constructing access roads satisfactory to the landowner.

See Rev. Rul. 71-354, 1971-2 C.B. 246, which deals with the treatment of the road credit on the part of the purchaser of timber under a timber cutting contract. Rev. Rul. 71-354, in part, holds that the amount expended by the purchaser for construction of specified roads for which a road credit is earned is to be (1) treated as logging road costs recoverable through depreciation deductions if such roads are to be used by the purchaser for harvesting the timber included under the contract, or (2) added to the purchaser's basis for cost depletion of the timber cut if such roads are not used by the purchaser for harvesting the timber.