A.3. Part III - Profit or Loss from Land and Timber Sales

(1) Part III provides for recording and reporting all dispositions of timber, timber cutting contracts, or forest land (whether or not taxable). The gain or loss from a sale or exchange of timber is equal to the proceeds reduced by the adjusted depletion basis of the asset and by any expenses directly related to the transaction.

(2) Generally, a taxpayer disposes of timber through one of three methods: a

lump-sum sale, a disposal with a retained economic interest, or through a cutting contract. A lump-sum sale of timber is the outright sale, usually by means of a timber deed or sale contract, of standing timber for a fixed total amount agreed to in advance. The income from an outright sale generally is capital gains if the timber is held for investment. If the timber is held for use in the taxpayer's trade or business for more than one year, it is usually IRC § 1231 gain.

(3) A disposal of timber with a retained economic interest is the disposal of

timber under any form or type of contract that requires payment at a specified rate for each unit of timber actually cut and measured. This type of transaction often is called a pay-as-cut contract. The income produced by a disposal with a retained economic interest is treated under IRC § 631(b) as IRC § 1231 gain or loss from the sale of the timber, regardless of the reason for which the timber is held. IRC § 631(b) treatment is available for timber held more than 1 year before disposal.

(4) The cutting of standing timber (felling) is part of the process by which

standing timber is made into logs or other products that are sold. The cutting of timber (for sale or for use in the taxpayer's trade or business) during the tax year by the taxpayer who owns, or has a contract right to cut, the timber is considered a sale or exchange of the timber cut during the tax year. A taxpayer who has owned timber, or has held a contract right to cut timber, for more than 1 year, can make an IRC § 631(a) election to treat the cutting of

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the timber for use in the taxpayer's trade or business as the sale of standing timber that will result in an IRC § 1231 gain or loss.

(5) Whether timber income is active, passive, or portfolio income depends on the

purpose for which the taxpayer owns the timber, and whether the taxpayer materially participates in the timber trade or business.