Part V. Assets that are placed in the land account include the land itself and

non-depreciable land improvements. Non-depreciable land improvements include earthwork assets of a permanent character, either acquired with the property or constructed later such as roadbeds of permanent roads, land leveling, etc. The basis of such assets can only be recovered when the taxpayer sells or otherwise disposes of the land.

(1) The examination of a tax return reflecting timber activity, whether for a

sawmill, landowner, logger or trucker, should always begin with a thorough pre-audit. The examiner should obtain all necessary information and records relevant to the case, especially documents to help reconcile/verify income. Additional research should be conducted in various ways. A web search is always a good start to determine if the taxpayer has a website or engages in e-commerce activities or has been covered by the media. Local county clerk offices' websites will indicate assets owned, including real estate. Landowner and logger associations should be researched within the taxpayer's state of operation for possible resources or additional information. The most obvious but often forgotten sources are the IRS Forest Products Subject Matter Expert, an IRS Forester and co-workers that have experience with a timber audit. (IRS foresters can be found by contacting any LB&I Engineering Team).

(2) Using the pre-audit information, the examiner should then prepare an in depth interview specific to the taxpayer. The following are some key questions to ask regarding timber, depending on the activity of the taxpayer being examined. Remember, any given taxpayer may fall into more than one of the categories below.

• How often do you sell timber?

  • How much property (acres) do you own? Where is it located?

  • Was the timber sold owned solely by you? If not who else shared ownership?

  • Do you have a contract for the sale? Provide a copy.
  • Did you receive Form(s) 1099? How many? If not, how do you determine gross receipts?

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• How did you receive payment? At the beginning, on a schedule or at the end of the deal?

• Did the deal/contract cover more than one tax year? Did it cover more than one sale? Did it cover more than one payment?

• If basis in the timber is claimed, how was that determined?

• Was the sale negotiated or did it go through a bidding process?

• Did you use a consulting forester or any other agent in selling the timber, or did you deal directly with the buyer? If so, provide name and contact information.

• Are you involved in any state programs that allow property tax relief for timber owners?

• If so, who administers this program and is there any particular individual with whom you deal?

• When did you acquire the property and was a timber inventory done at that time?

• Do you have a management plan for the timber property?

• Do you have a conservation easement on the property? If so, who holds the easement?

• Have you ever made an election under IRC § 631(a)?

• Have you received any cost share payments under IRC § 126 for the years under audit?

• Did you receive Form(s) 1099? How many? If not, how do you determine gross receipts?

• How did you receive payment? At the beginning, on a schedule or at the end of the deal?

• Did the deal/contract cover more than one tax year? Did it cover more than one sale? Did it cover more than one payment?

• If basis in the timber is claimed, how was that determined?

• Was the sale negotiated or did it go through a bidding process?

• Did you use a consulting forester or any other agent in selling the timber, or did you deal directly with the buyer? If so, provide name and contact information.

• Are you involved in any state programs that allow property tax relief for timber owners?

• If so, who administers this program and is there any particular individual with whom you deal?

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• When did you acquire the property and was a timber inventory done at

that time?

• Do you have a management plan for the timber property?

• Do you have a conservation easement on the property? If so, who holds

the easement?

• Have you ever made an election under IRC § 631(a)?

• Have you received any cost share payments under IRC § 126 for the

years under audit?

• How do you obtain new work? Word of mouth, advertising, etc.?

  • Do you work for one particular sawmill or several? Name them.

  • Do you have contracts for each job or with each sawmill? Provide copies.

  • How do you determine the cost of each job? Do you bid for jobs? Is there

a negotiation process? How is final cost determined?

• How do you receive payment? By the job, by the contract, on a schedule

of job completion.

• Do you receive Form(s) 1099? From all jobs? If not, how do you determine

gross receipts?

• Has there been a time when you did not receive a Form 1099? What did

you do to report the income?

• Do you buy timber outright from the timber owner?

• Do you enter into agreements with landowners to cut timber and sell the

logs and give the owner part of the money that you receive? Are these written agreements?

• Are you an independent contractor or an employee?

  • If independent, do you work for loggers, the sawmill or both? Provide a list

for the tax year under examination.

• Do you have a contract(s)? Please provide.

• How is the cost of the job determined? Explain.

• How do you receive payment?

• Do you receive Form 1099s? From all jobs?

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• If you do not receive Form 1099s, how do you determine your gross

receipts?

• Do you employ loggers and truckers, or do you contract out for these services?

  • Do you own land that is logged and/or do you purchase from other timber owners?

  • Do you have contracts or agreements with these timber owners? Provide copies.

  • Do you specialize in the type of logs you purchase? If so, explain.

  • Do you cut for specific orders, or do you cut for general production?

  • If you cut for specific orders, do you have agreements with the customers?

Provide copies.

• What do you do with your by-products like sawdust and bark slabs?

• When do you receive payment for an order?

• Do you have standing or recurring orders with any customers?

• Who is responsible for shipping costs?

• Is the product being shipped insured by you or the customer? What

happens if the product is damaged or destroyed during shipping?

• How do you determine gross receipts?

• Do you secure Forms W-9 from all contractors? Do you issue Forms

1099? Provide copies of both. If not explain why.

• Do you issue Forms 1099 to timber sellers for lump-sum or pay-as-cut

purchases? If not, explain why.

• Ask for a complete list of customers the Taxpayer did business within the

tax year under examination.

(1) The examiner's initial interview should take place at the taxpayer's place of

business and in most cases will help the examiner to determine income sources and evaluate internal controls. In addition to the questions listed above, the examiner should include questions used in other examinations regarding general income and internal controls. In addition, many other examination issues, such as depreciation and repair expense, may be present. While at the taxpayer's place of business, the examiner should conduct a tour with the taxpayer or someone familiar with the operations. The scope of the tour will depend on the type of timber operator being examined.

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Be sure to observe the product on site in all stages - raw goods, partially processed, processed goods ready for shipping and by products. Look for trucks and equipment and ask who owns each item and for what business activity it is used.

(2) Most hardwood timber operators are small operations conducted in a fairly

small geographic area. Some are family operations lacking certain elements of internal controls. Lack of internal controls and poor record keeping create opportunities for taxpayers to under-report income. These situations leave little or no audit trail.

(3) If, after conducting the initial interview, touring the business site and

reviewing the books and records, the examiner determines that there is little or no audit trail, the examiner may use an indirect method to verify income. The examiner should consider using the bank deposit indirect method or the source and application indirect method. The examiner also may consider expanding the scope of the audit to include related entities. For instance, if the key taxpayer is a corporate sawmill, the case may have to be expanded to include each shareholders' personal tax return.

(4) The examiner also should consider making third party contacts with

customers and other sawmills in the area. Additionally, the Examiner should evaluate the taxpayer's ability to support the expenses (deductible and nondeductible, business, and personal) with the amount of income reported and any non-taxable income received.

(5) Third party contacts are a good, reliable resource for income identification.

There are four general types of timber returns. They are land/timber sellers, loggers/timber operators, truckers, and sawmills. The following is a general list of third party contacts that can be used for almost all timber returns:

• Taxpayer's known customers;

• Courthouse records of timber deeds;

• Real property tax receipts;

• Logger or broker purchase records;

• Federal or state Forest Services;

• Consulting foresters;

• Sawmill or concentration yard purchase records;

• Timber severance taxes (where applicable);

• Related timber purchases on a per job basis;

• Verification of a trucker's drivers, cutters, and skidder operators, including income arrangements; and

• Customer purchase records.

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(6) After income sources have been identified, it is necessary to contact these

sources to request documentation pertaining to the taxpayer being examined. The examiner should request that these sources provide documentation such as invoices, canceled checks, contracts, etc. Use diligence in gathering all relevant data because in many cases the source records may be incomplete. Sometimes these records may have limited data such as only a name and an amount. This makes it very difficult to identify the payee; even if the payee was paid by check (checks may be cashed rather than deposited). In many cases, the examination may require a combination of third party contacts to identify unreported income. If the third party does not comply with your request, you should consult your manager to determine if a summons should be sent to that party. Summonses to banks should be considered to verify that the taxpayer has disclosed all bank accounts.

(7) As mentioned above, land/timber sellers, loggers/timber operators, truckers

and sawmills may have limited internal controls, thus increasing the probability of error. For example, often there will be missing or unavailable invoices or other documentation to support expense deductions. Standard audit techniques should be used to examine expenses. Examiners should properly consider the cost of goods sold (COGS) during their examinations as it is usually the second largest dollar volume item on a tax return after gross income.

(8) COGS and Other Deductions easily can be used to cover a multitude of

incorrectly treated expenditures. The IRM requires minimal inventory checks. See IRM 4.10.3.10.4.3 for additional information on techniques.

(9) The types of expenses a timber industry taxpayer can deduct are very similar

to those of any other business. Differences do exist; generally, these expenses are necessary to produce income. Some of the most common areas of potential noncompliance are:

• Personal expenses of a shareholder paid out of corporate accounts but still deducted on the corporation's tax return. The examiner should keep in mind that if this situation is discovered the adjustment is two pronged. First, the personal expense must be disallowed to the C Corporation and then assessed as a dividend to the shareholder. Similarly, if the taxpayer is an S corporation the personal expense is disallowed but then the disallowed personal expense amount must be considered in the basis computation of the shareholder.

  • Expenses are overstated with no supporting documentation. Some timber industry taxpayers may deal in cash and may not keep applicable receipts. When taxpayers deal in cash, they will usually verify expenses by providing paid invoices only because they have no cancelled checks. If the Examiner has a double entry set of books, close attention should be paid to journal entries in the expense accounts. If the taxpayer is paying in

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cash and the cash was not deposited, they need a journal entry to book the expense. Examiners should be sure to trace all cash payments to the source of the cash.

• If an examiner has determined that their timber audit requires them to

address issues under IRC §§ 183 or 469 then they should examine those issues using either the IRC § 183 Activities Not Engaged in for Profit ATG or the Passive Activity Loss ATG. These guides will address how the examiner should evaluate the facts of their case to determine if IRC §§ 183 or 469 applies under timber industry norms. The examiner is expected to evaluate the activity as a whole and carefully determine the substance of the activity to arrive at their position.

(1) Prices for hardwood timber rise and fall as do many commodities based upon

demand and availability. Hardwood prices also will vary by species, timber quality, variability of terrain, distance from mills, distance to public roads and the knowledge of the landowner on timber value at the time.

(2) A landowner may sell his timber in several ways. The landowner may

negotiate a price with a timber buyer (connected to a specific mill or independently) or by using a consulting forester who marks the timber and puts it up for bid by advertising with buyers in the area. In these cases, the buyer will usually contract the felling and delivery of the wood to a third party contractor. A landowner may also arrange with a logger to cut the timber and haul the logs to a mill for sale and then the logger and landowner split the proceeds (sometimes referred to as a percentage sale), or the landowner may sell the timber directly to a logger who will then market the logs and keep all proceeds.

(3) Throughout the discussion on revenue, it is important to keep in mind that

timber is considered the volume of wood in the standing tree prior to severance from the stump. It is considered real property and capital gains property. On the other hand, logs are the volume of wood from trees severed from the stump and are personal property. The sale of logs from timber held for more than one year is generally capital gains property subject to tax treatment under IRC § 1231.

(4) Standing timber is usually purchased in one of three ways:

• outright purchase of the land and related timber.

• purchase at a specified rate per unit of timber actually cut (pay-as-cut);

and

• purchase for a set total amount or lump sum.

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(5) When the company pays the owner of standing timber under a pay-as-cut

contract, the payment for that timber is a royalty and it must be reported on Form 1099-S, unless the recipient is a corporation. This type of sale is also known as an IRC § 631(b) sale because it is covered in IRC § 631(b). As of May 28, 2009, when a buyer purchases standing timber for a lump sum, that payment also must be reported on Form 1099-S. The Form 1099-S reporting requirement is placed on the purchaser of the timber regardless of who the purchaser is: mill, broker, logger, etc. The instructions for Form 1099-S contain additional information. Treasury Regulation § 1.6045-4 was amended to require Form 1099-S for lump sum sales.

(6) Payments to independent contractors for cutting timber are compensation for

services performed, and payments of $600 or more must be reported on Form 1099-MISC in the nonemployee compensation box. However, payments to independent contractors that only cover the purchase of logs and not the service of cutting do not need to be reported because they are payments for merchandise.

(7) When gross income is established, the profit or loss on the sale or other

disposition of timber is determined by reducing the amount received for the timber by the cost or other basis of the timber and any expenses incurred in making the sale. The cost or basis of the timber and the sales expenses are considered cost of goods sold.

(8) Sale Proceeds - Cost or Basis - Minus Sales Expenses = Net Profit or Loss.

(9) The examiner should consider reviewing the following documents to verify

timber income.

• sales contracts;

• timber deeds;

• closing statements;

• timber scale tickets for record of each load of timber harvested;

• selling expenses from disposal invoices;

• workpapers reconciling the amounts reported on the sales source,

documents to the amounts reported for tax purposes; and

• any other data that is helpful in verifying the timber income.

(1) The basic rule is that ordinary and necessary expenditures associated with

the production of timber held with the intention of making a profit can be recovered in three basic ways:

• Capitalized expenditures are entered into an asset account for recovery

through depreciation, amortization, depletion, or other means;

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• Operating expenses generally are deductible from gross income for the

tax year in which the expenditure is paid or incurred; and

• Selling expenses associated with a timber disposal are deducted from

gross sale proceeds to determined net profit or loss.

(1) Capital expenditures are costs incurred for acquisition of property (or

property rights) or permanent improvements that increase the value of property already owned. Capital expenditures must be capitalized instead of being immediately expensed. It is necessary to examine accounts to ensure proper recording of the original cost, amounts recovered, and additions for improvements.

(2) At the time of acquisition, the total cost is allocated among the assets

included in the purchase. The amount allocable to land itself is the portion of the total acquisition cost attributable to the bare land. Land cannot be depreciated or depleted. The value of land can only be recovered through disposal by sale, exchange, bequest, etc. For purchases that are not made at the FMV of the property, the basis of each asset must be determined by using the proportion of the FMV of that asset compared with the FMV of all assets and compared to the total acquisition cost. This method is discussed in greater detail below under Establishing Cost or Basis.

(1) Assets placed in the land account include the land itself, non-depreciable

improvements, and depreciable land improvements. The value placed in this account may result from sale, exchange, bequest, etc.

(2) Non-depreciable land improvements are primarily earthwork enhancements

of a permanent character such as clearing for and constructing roadbeds of permanent roads, land leveling, and impoundments. These amounts generally may only be recovered through disposal of the land. Initial property surveys should also be capitalized into the non-depreciable land account. Depreciable land improvements include bridges, culverts, graveling, fences, firebreaks, etc. These types of improvement costs are recoverable through depreciation.

(3) There are two basic types of logging truck roads for tax purposes permanent and temporary. Permanent roads, sometimes called long-term, are those with an undeterminable useful life to the taxpayer. They are intended not only for timber harvesting, but also for general management activities, including fire control. A temporary or timber access logging road, by contrast, is constructed solely to remove certain timber and is then abandoned.

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(4) The tax status of permanent roads is clear. Construction costs of the non depreciable portions must be capitalized and are not recoverable unless the road is sold or abandoned (for adequate reason). The parts that must be replaced from time to time are depreciable. These land improvements include bridges, trestles, fences, culverts, and surfacing. Their costs are recoverable through depreciation. Depreciation is allowable whether the road has a useful life to the taxpayer of one year. Finally, maintenance costs not related to basic construction are deductible as business expenses in the tax year incurred. However, these costs are limited to Form 1040, Schedule A, Miscellaneous Other Deductions, if the asset is held for investment purposes. Assets held for personal use are not deductible. Maintenance costs include items such as grading or adding gravel. Please note, the Tax Cuts and Jobs Act eliminated or limited many itemized deductions in tax years 2018 through 2025.

(5) The tax treatment of permanent logging truck roads differs somewhat if,

rather than owning the land and timber to which the road is associated, the taxpayer only has the right to timber by means of a long-term lease or cutting contract. In this case, if a taxpayer builds a permanent road that becomes the property of the landowner at the end of the agreement, the taxpayer may recover the depreciable portions of the road. On termination of the agreement, any remaining basis that the taxpayer has with respect to the depreciable portion of the road would be recoverable in that tax year. For the non-depreciable portion of the road, an equal part may be taken as a business deduction over the life of the agreement. If, for some reason, the road does not revert to the landowner at the end of the agreement, the taxpayer continues to recover any depreciable basis.

(6) The costs of temporary logging truck roads are recoverable through

depreciation. Under the modified accelerated cost recovery system (MACRS), the costs are recoverable over 15 years as a land improvement under Asset Class 00.3. See Rev. Proc. 87-56, 1987-2 C.B. 674, clarified and modified by Rev. Proc. 88-22, 1988-1 C.B. 785, or by a unit-ofproduction method. Under the unit-of-production method, recovery of cost occurs in proportion to the removal of the volume of timber for which the road was constructed.

(7) According to Rev. Rul. 68-281, 1968-1 C.B. 22, the total costs of a temporary

road, including the costs of clearing, grubbing, rough cut, and fill grading, are recoverable.

(8) The holding of Rev. Ruling 88-99, 1988-2 C.B. 33, indicates that any road,

regardless of its physical attributes, must have a useful life to the taxpayer that is determinable in order for depreciation to be available.

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(1) When a timber tract is purchased, a part of the total cost is allocable to the

timber. This allocation is based on the relative value of the timber to the total value of the assets acquired. This cost is recovered by the taxpayer through allowable basis if the timber is disposed of on the stump or depletion if cut by the owner.

(2) If the value of the young growth is significant, a portion of the purchase cost

should also be allocated to it, based on its relative value at the time of acquisition. When the young growth trees become merchantable, the volume and basis of the timber in these trees are transferred to the merchantable timber account.

(1) The Plantation sub-accounts are used to record the costs associated with

reforestation or forestation by natural or artificial means, such as planting or seeding. All costs associated with regeneration are included, for example, site preparation (tree girdling, brush or stump removal, land leveling, and conditioning), seed or seedling, pro-rated cost of equipment used, and paid labor. IRC § 194 allows tax deductions for the cost of reforesting timberland following a harvest or for planting previously open land. A taxpayer may deduct the first $10,000 ($5,000 for married couples filing separately) per tax year of such costs per qualified timber property. Any additional amount may be amortized over 84 months. Establishing hardwood regeneration is generally not as intensive as for conifers. Most of these types of costs are associated with conifer plantations and not all apply to hardwoods.

(1) Assets placed in the equipment account include the cost of durable

equipment such as a sawmill, trucks, tractors, power saws, etc. Subaccounts are normally used by larger companies. The cost of any major repairs or reconstruction that materially increases the value or extends the life of these items is added to the equipment account.

(1) Operating expenses are broad classes of costs that can be defined as all

those costs that are not capital costs and are not associated with the sale or disposal of an asset. The ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business may be deducted per IRC § 162. The examiner should be aware that most of these expenses can lend themselves to personal use. The personal use portion of these expenses is not deductible and an allocation for business use must be made. The examiner should verify the business purpose and how it relates to the timber operation. This is done by interview questions, observation and inspection of invoices, receipts, policies, and other documents.

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(2) In addition, an individual may deduct ordinary and necessary expenses for

the production or collection of income or for the management, conservation, or maintenance of property held for the production of income per IRC § 212. The following items are examples of some types of deductible operating expenses:

• Tools of short life or small cost include axes, handsaws, sledges, wedges,

etc. These are generally items replaced almost every year.

• Maintenance costs include incidental repairs of trucks, tractors, and other

mechanical equipment. These costs usually are oil changes, inspection, tire rotation, tune-ups, cleaning, etc.

• Salaries or other compensation for services rendered by others, such as

hired labor, fees for consulting foresters, lawyers, accountants, etc., provided these expenditures are not directly related to any activity, such as timberland purchases, reforestation projects, or timber sales. These expenses would be capital in nature if so related.

• Taxes such as property, severance, gasoline, and license fees for

business vehicles. Federal income tax, estate, inheritance and gift taxes, and special assessments for local benefits are not deductible.

• Interest payments on bank loans and other short-term credit, and longterm indebtedness such as mortgages. Note: Individual personal interest

is not deductible.

• Premiums for fire, windstorm, theft, or other business insurance, such as

public liability and workmen's compensation are deductible.

• Travel expenses while away from home on business may be deductible

under certain circumstances.

• Rent or other payments for land, equipment, or other business property in

which the taxpayer has no equity.

(1) All costs associated with specific timber sales are selling expenses. These

costs are recovered by deducting them from the proceeds of the sale(s). The following is a listing of items that are considered directly attributable to a disposal of timber per Rev. Rul. 71-334, 1971-2 C.B. 248:

• Advertising the timber for disposal;

• Cruising to determine the quantity and quality of timber to be disposed;

• Marking or otherwise designating the timber for cutting;

• Marking seed trees to be retained;

• Scaling, measuring, or otherwise determining the quantity of timber cut;

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• Fees paid to consulting foresters, selling agents, and others for service

directly related to timber disposal;

• Supervising or checking performance under the contract; and

• Other expenses directly attributable to the disposal.

(1) The basis (book value) of timber should be established at the time it is

acquired. This is needed to calculate the depletion deduction and to determine the taxable gain (loss) when timber is sold on the stump, cut, or disposed of involuntarily, such as by a casualty or condemnation. Real estate is usually acquired for a single amount, even though more than one asset is included. To recover the portion of the basis attributable to any one asset, such as timber, a separate basis must be established for that asset. In the case of timber, this most often means separating the amount paid for the land from the amount paid for the timber.

(2) The allocation of basis between assets should be based on the proportion of

the fair market value (FMV) of the asset to the total FMV of the property acquired. This requires estimating the FMV of each asset individually. Note: In some cases, the sum of the FMV of the individual assets will be greater than or less than the FMV of the combined assets. The taxpayer must make a reasonable effort to estimate the FMV of each asset. A reasonable estimate for five acres of low grade timber may be based on readily available information, such as published price reports. However, for a larger tract and/or higher-value timber, this approach would be unreasonable. An appraisal by an experienced forester would be more appropriate.

(3) FMV is the price at which an asset would change hands between an

unrelated willing buyer and an unrelated willing seller. Sales of similar property (comparable) on or about the valuation date are the best indicators of FMV. In addition, a taxpayer must consider the following factors when estimating the FMV of timber property:

• Character and quality of the timber as determined by species, age, size,

condition, etc;

• The quantity of timber per acre, the total quantity under consideration, and

the location of the timber in question with reference to other timber;

• Accessibility of the timber (location with reference to distance from a

common carrier, the topography and other features of the ground upon which the timber stands and over which it must be transported in process of exploitation, the probable cost of exploitation and the climate and the state of industrial development of the locality); and

• The freight rates by common carrier to important markets.

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(4) If a tract contains a mix of high value and low value species of merchantable

size, consideration should be given to establishing separate cost basis for each type of timber. This will allow the taxpayer to match income and expenses more clearly on the disposition of any timber.

(5) The procedure used to allocate the available basis between assets is the

same no matter how the property is acquired. However, the total basis available for allocation will depend on how the property was acquired. The basis of purchased property is the amount paid to the seller, plus any additional costs incurred in the process of acquiring property. The purchase price may have been in the form of cash, other property, or a combination of both. Additional acquisition costs include amounts paid for attorney's fees, surveying, a timber cruise, real estate taxes owed by seller, and any other costs directly associated with the acquisition. The basis of property acquired through gift or inheritance is discussed in Section IV.

(6) Detailed instructions on how timber basis should be established and adjusted

are found in Treasury Regulations § 1.611-3.

(7) The appropriate time to establish a separate cost basis for timber is when the

property is acquired. It may be necessary to establish a basis later if not done at the time of acquisition. This can be done if the necessary information as of the date of acquisition is available. Taxpayers who acquired timber several decades ago and have not previously established a separate basis may find the cost of doing so now exceeds the benefits. This is a determination that should be made by the taxpayer on a case-by-case basis.

(8) The information needed to establish a separate cost basis for timber at a

later date is the same as that needed if the allocation were made at the time of acquisition. To estimate the FMV of the timber at the time of acquisition, it is necessary to estimate the volume and type of timber that was present on the land at that time.

(9) The taxpayer is required to estimate, with respect to each separate timber

account established, the total units (board feet, cords, or other units) of timber reasonably known, or on good evidence, believed to have existed on the date of acquisition of the property.

(10) If records do not exist to determine this estimate, forest measuring, and

mathematical techniques can be used to reverse the growth of the current forest back to the date of acquisition for a reasonable approximation of volume at time of acquisition. A professional forester should perform this task. The forester should consider factors such as growth period, growth rate, weather, insects, forest fires, etc.

(11) After the volume by type has been estimated, the FMV of the timber on the

date of acquisition must be estimated. The best available evidence of timber values on this date must be used. Ideally, the price actually paid for timber similar in character and quality in the location of the subject property on or near the valuation date should be used. Consulting foresters or timber buyers

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with records dating back to that period may be good sources of this data. Otherwise, published price reports may be used to develop acceptable estimates if the average prices are adjusted to reflect differences between averages and the particular location and timber in question. The FMV of the timber then has to be balanced against the FMV of the other assets at the time of acquisition, as discussed above.

(12) In addition to the FMV of the assets as of the date of acquisition, it is also

necessary to determine the volume of timber disposed of, if any, since acquisition. This is because the volume and basis must be reduced by the basis allowable for any previous sales, even if the basis was not claimed on the tax return for the tax year of the sale.

(13) An IRS Forester can assist the examiner with determining if the basis of the

land and timber established by the taxpayer is correct.

(14) The Form T and Form T Instructions are useful to determine and track

timber volumes, basis, and activities.

(15) The examiner should consider reviewing the following documents to verify

basis:

• purchase contracts;

• closing statements;

• timber deeds;

• appraisals allocating the purchase price to the land, young growth,

merchantable timber, other assets;

• cost records for any plantations established;

• timber cruises / forester reports with workup information prepared at the

time of purchase establishing timber volumes, types, and fair market values;

• timber cruises / forester reports with workup information prepared at the

time of sale establishing timber volumes, types, and fair market values;

• Form T detail information from the time of acquisition through the year of

disposal, reflecting changes in the timber account as a result of purchase, sale, cutting, reestimate, or loss;

• workpapers reconciling the amounts reported on the acquisition source

documents to the amounts reported for tax purposes; and

• any other data that is helpful in verifying the cost / adjusted basis /

depletion.

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(1) Mr. and Mrs. A. Dell purchased a tract of rural land. The land was purchased

primarily as an investment. The tract produces income from several sources. The pasture and barn are rented to a local farmer and the house is rented to a local family. In addition, the woodlands include many prime stands of mixed hardwoods.

(2) The 120-acre tract was purchased for $135,000. The costs associated with

the purchase include the purchase price and fees paid to professionals for services rendered. (BF = Board Feet and MBF = 1,000 BF.

(3) The following chart reflects purchase price of farm - $135,000, Legal fee (title

search) - $420, Surveyor fee (cruising, valuing timberland) - $1,200, Consulting forester fee - $800, Misc. selling expenses - $380, Total Cost or Basis - $137,800.

(4) The total cost must be allocated among all the assets acquired. This

allocation requires the assistance of experts.

(5) The following chart reflects: House - FMV $12,000, 6.62%, Cost $9,122.36,

Barn - FMV $8,000, 4.42%, Cost $6,090.76, Fences - FMV $1,400, .77%, Cost $1,061.06 Timberland (90 acres at $120/acre) - FMV $10,800, 5.96%, Cost $8,212.88, Pasture Land (29 acres at $800/acre) - FMV $23,200, 12.81%, Cost $17,652.18, Home Land (1 acre at $1,600/acre) - FMV $1,600, .88%, Cost $1,212.64, Merchantable timber (12 MBF/acre at $110/acre) FMV $118,800, 65.56%. Cost $90,341.68, Young growth timber ($60/acre) FMV $5,400, 2.98%, Cost $4,106.44, Total - FMV $181,200, 100%, Cost $137,800.

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(1) Continuing with Example 1, assume that the Dells sell all the merchantable

timber on the 90 acres in the same tax year that they purchased it. The contract price is $110/MBF and the volume estimate of 12 MBF/acre is used.

(2) The following chart reflects the net gain from the sale: 90 acres x $110/MBF

x 12 MBF – $118,800, Allowable basis (cost basis) - ($90,342), Sales expenses - ($5,940), Net Gain - $22,518.

(3) The computation of net gain in Example 2 was simplified by the assumption

that all of the merchantable timber was sold at the same time and in the tax year that it was purchased. Assuming a holding period requirement of one year, the gain would have been short-term capital gain, making it possible to reduce the sale proceeds by the entire cost basis of the timber. If only a portion of the timber is sold, only a corresponding portion of the cost basis may be reduced. This partial reduction in cost basis is determined by multiplying the number of units (volume) sold by the depletion unit.

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(1) Referring to Example 1, assume the Dells sell 450 MBF in year 1, instead of

all the timber in Example 2. The depletion unit for the timber is $83.65/MBF, obtained by dividing $90,342 by 1,080 MBF. The contract price is $110/MBF and the selling expenses total $3,500.

(2) The following chart reflects: Gross Income (450 MBF x $110/MBF) - $49,500,

Allowable basis (450 MBF x $83.65/MBF) - ($37,643), Sales Expenses ($3,500), Net Gain $8,357.

(3) As shown in Example 3, the depletion unit is the cost per unit of volume

obtained by dividing the basis of the timber by the volume of timber.

(4) The calculation becomes more complicated if a year or more elapses

between the acquisition and the sale of the timber. It is necessary to adjust the volume of timber for growth. It also is necessary to adjust the cost basis if any costs were capitalized during the period or a portion of the basis was recovered.

(5) The initial volume entered in the timber account should be the estimated total

volume that the tract would produce on the date of acquisition if all the timber was cut and utilized in accordance with the standards of utilization prevailing in the region at the time.

(6) The timber account must be adjusted as needed to reflect the following

charges:

• Volume of additional timber purchased or otherwise acquired during the period.

• Transfer from the young growth or plantation accounts to the merchantable timber account of the volume of timber that becomes merchantable during that period, and its basis.

• Volume gained through growth since last adjustment.

• Volume removed through sale or other disposition or lost due to natural or other cause.

(7) Timber companies generally make annual adjustments for growth. However,

owners of smaller timber holdings who have infrequent timber transactions generally make these adjustments only in a tax year in which they cut, sell, or

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otherwise dispose of timber. One way for small producers to account for timber growth may be to re-cruise the entire timber tract. This can be accomplished at the same time that the timber is marked or otherwise designated for sale.

(8) Any additions or reductions to timber basis that have occurred since the last

adjustment must be reflected in the timber account before the depletion unit is calculated. The volume and cost basis used to calculate the depletion unit for a given tax year must be the adjusted volume and adjusted cost basis. The adjustments should be made to reflect the actual volume available for harvest and the unrecovered cost basis as of the end of the tax year (before depletion or other reduction of basis) for which the depletion unit is calculated.

(1) Referring to Example 3, assume that the Dells sell 900 MBF in the 10th year

of ownership. During the Dells' ownership, the following transactions have occurred:

• A timber stand improvement (TSI) was made at a net cost of $60/acre,

which was capitalized.

• Twenty-acre tract containing 300 MBF of timber was purchased for

$30,000. The timber accounted for 2/3 of the purchase price or $20,000 and was added to the timber account previously established.

• The merchantable timber had an average net growth of 350 BF per acre

per year. (350BF/1,000 = 0.350 MBF).

• The young growth reached merchantable size. Its average net growth was

350 BF per acre per year. (350 BF/1,000 = 0.350 MBF).

(2) The following chart reflects a timber basis analysis: Original Cost (Tax Year

1. • $90,342, Timber Sale (Tax Year 1) - ($37,643), TSI (90 acres at $60/acre) - $5,400, Purchase Jones Tract - $20,000, Transfer from Young Growth (Ex. 1) - $4,106, Adjusted Basis - $82,205.

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(3) The following chart reflects a timber volume analysis: Original Volume (Tax

Year 1) - 1,080 MBF, Timber Sale (Tax Year 1) - (450 MBF), Purchase Jones Tract - 300 MBF, Transfer from Young Growth (.350 MBF X 90 acres x 10 years) - 315 MBF, Growth (.350 MBF x 90 acres x 10 years) – 315 MBF, Adjusted Volume - 1,560 MBF

(4) If the contract price for the sale is $145/MBF and selling expenses are

$8,000, the net gain is computed in the following way:

(5) The following chart reflects a gain computation analysis: Gross Income (900

MBF x $145/MBF) - $130,500, Allowable Basis ($82,205/1,560 MBF = $52.70) (900 MBF x $52.70/MBF) - ($47,430), Selling expenses - ($8,000), Net Gain $75,070

(6) If, instead of selling the timber, the owner cuts the timber, produces, and

sells logs, the depletion allowance is calculated in exactly the same manner as the allowable basis. Although depletion occurs when timber disposal occurs, depletion is not allowable until the logs are sold or otherwise disposed. Furthermore, no depletion allowance can be claimed for timber cut for personal use such as home firewood. The basis for depletion must be reduced by the cost attributable to the personal use timber.

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(7) The tax treatment of a disposal of standing timber depends on the primary

purpose for which the timber is held, the holding period and the manner in which the timber is disposed. The holding period is determined from the date the timber, or the contract right to cut the timber, is acquired until it is considered cut.

• If the timber is held for investment for more than one year and is sold either in a lump sum sale or in a pay-as-cut contract, the disposal of timber will produce long-term capital gains or losses.

• If the timber is held for less than one year, it will be treated as a short-term capital gain or loss. If the timber is held as part of a trade or business, the treatment of the sale depends on the holding period. Timber held for use in a taxpayer's trade or business and held for more than one year is considered § 1231 property. The gains or losses on the sale of such property are netted with other § 1231 gains or losses, with the resulting net gains treated as capital gains and the resulting net losses treated as ordinary losses. No asset held for one year or less is ever given IRC § 1231 treatment.

• Lump-sum Sale - Occurs when timber is sold for a set price regardless of the volume of timber actually cut. The timber to be disposed of may be specified by various means such as marking trees within a specified area or trees of a certain species.

• Pay-as-Cut Contract - This type of sale is also known as a "disposal with a retained economic interest" or an IRC § 631(b) transaction. Timber is sold and payment made as it is cut and measured, with total price paid depending on the volume cut.

• Some taxpayers may be eligible to elect to treat the cutting of their own timber for sale or use in their business as a sale or exchange of the timber under IRC § 631(a). To be eligible to make the election, the taxpayer must have owned the timber or a contract right to cut the timber for more than one year and the timber must be for sale or for use in the taxpayer's business. If the taxpayer makes the election, the difference between the adjusted basis of the timber cut and its FMV on the first day of the tax year in which it is cut is treated as an IRC § 1231 gain or loss. Income received by the taxpayer from additional processing of the timber once cut is ordinary income or loss. The election must be made with the original tax return for the tax year to which it first applies. Once made the election is binding on the taxpayer for the tax year for which the election is made and all subsequent tax years. To discontinue using this method the taxpayer must receive consent from the IRS.

• If the timber is held for personal use, the sale will produce a capital gain or loss. The capital gain or loss will be either long-term or short-term depending on the length of time the timber was held.

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(1) Generally, the basis for gifts of property is the same as the basis in the hands

of the donor. However, if the donor’s basis is greater than the FMV of the property at the time of the gift, for purposes of determining loss the basis is FMV. See IRC § 1015(a). Note: The that the basis of the gift can be increased by the amount of any gift tax paid on the gift, but not in excess of the FMV at the time of the gift.

(2) Generally, the basis of property acquired from a decedent is the FMV of the

property on the date of decedent's death or the alternate valuation date. See IRC § 1014(a). If the decedent's estate has elected to value the property under IRC § 2032A, then the value is determined under that tax provision. Note that the value of property reported on an unexamined federal or state estate tax return is not determinative of the FMV. As with unfiled estate tax returns, the basis is determined only under IRC § 1014. There are also special rules for decedents dying in 2010 if the executor elects to apply carryover basis rules rather than the FMV of the inherited property under the general tax provisions.

(3) If timber is not separately listed on the federal estate tax return or state tax

form, its FMV on the date of death, or the alternative valuation date, will need to be determined and allocated to the timber. For example, if timber and timberland have been valued together, a taxpayer must use the allocation procedure demonstrated in Section III. However, the value reported on the estate tax return will be used instead of the acquisition cost.

(1) Subcontractors are commonly used in the timber business. Some taxpayers

treat workers as other than employees to avoid paying employment taxes. Employees could be misclassified as subcontractors, contract labor or independent contractors. Backup withholding could apply to subcontractors. If you have a potential employment tax issue or a worker reclassification issue, refer the issue to the Employment Tax Specialty Group to work. Examiners may use the Specialist Referral System to obtain assistance.

(1) The most common area of excise taxes for the timber industry applies to

certain highway motor vehicles. A highway motor vehicle includes any motor vehicle designed to carry a load over public highways, whether or not also designed to perform other functions. A public highway is any road in the

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United States that is not a private roadway. This includes Federal, state, county, and city roads.

(2) A vehicle consists of a chassis, or a chassis and body, but does not include

the load. Examples of vehicles that are designed to carry a load over public highways include buses, highway-type trucks, and truck tractors.

(3) The following vehicles are generally not considered highway vehicles:

• Specially designed mobile machinery for non-transportation functions.

• Vehicles designed for off-highway transportation.

• Trailers and semi-trailers designed for non-transportation functions off the

public highways.

(4) A trailer or semi-trailer is not a highway vehicle if it is designed only as an

enclosed stationary shelter for conducting a function at the off-highway site of construction, manufacturing, mining, processing, framing, drilling, timbering, or similar operations.

(5) Only certain trucks and truck tractors are subject to excise tax. A truck is a

motorized vehicle that usually carries cargo on the same chassis as the motor. A truck tractor usually does not carry cargo on the same chassis with the motor. It is used mainly to pull a trailer or semi-trailer.

(6) A truck would not include a skidder, which is a four wheeled machine used to

skid felled trees. In addition, a truck would not include a bulldozer. These vehicles are not designed to carry a load on public highways.

(7) The taxpayer is subject to the highway use tax if his truck or truck tractor

meets all of the following tests:

• It is a highway motor vehicle, as discussed earlier;

• It is required to be registered for highway use;

• It is used on a public highway; and

• It has a taxable gross weight of at least 55,000 pounds.

(8) The truck or truck tractor, together with the semi-trailer or trailer customarily

used with it, must have a taxable gross weight of at least 55,000 pounds.

(1) If any highway motor vehicle with a taxable gross weight of at least 55,000

pounds is registered or required to be registered, the taxpayer must keep sufficient records for the Service.

(2) The following is a list of recommended records that the taxpayer should

keep:

• A description of the vehicle, including vehicle identification number (VIN).

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• The weight of loads carried by the vehicle.

• The date of acquisition including the name and address from whom the

vehicle was acquired.

• The date in which taxable use first occurred.

• The date and sale or other transfer of the vehicle including the name and

address of the person to whom the vehicle was transferred.

• If the vehicle was disposed of, but not sold or transferred, the records

must show how and when the disposition occurred.

• If the tax is suspended for a vehicle due to mileage on the public highways

being 5,000 miles or less, keep a record of actual highway mileage.

(1) The tax on highway motor vehicles is a graduated tax that based on the

taxable gross weight of the vehicle.

• If the taxable gross weight is at least 55,000 pounds but not over 75,000

pounds, then the rate of tax is $100 a year plus $22 for each 1,000 pounds.

• If the taxable gross weight is over 75,000 pounds, then the rate of tax is

$550.

(1) The highway use tax is reduced by 25 percent for any highway motor vehicle

if:

• During the tax period, the vehicle is used exclusively to transport products

harvested from a forest;

• Products are transported to and from a point within the harvested forest;

and

• It is registered as a highway motor vehicle used in the transportation of

harvested forest products.

(2) The Office of Chief Counsel has issued an opinion on the definition of trucks

used for logging. See IRS CCA 200949037 released July 1, 2009. In this document, the IRS concluded that a state-registered logging vehicle used exclusively for transporting forest products from a forested site qualifies as a logging vehicle under IRC § 4483(e) and is eligible for the reduced heavy vehicle use tax rate.

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(1) The highway use tax is reported and paid using Form 2290, Heavy Highway

Vehicle Use Tax Return. Form 2290 must be filed by the last day of the month after the month the vehicle is first used on the public highways. The tax period runs from July 1 of the current tax year through June 30 of the next tax year. File a separate Form 2290 for each month in which a taxable vehicle is first used during the tax period. If additional taxable vehicles are placed in use during a month in the tax period after filing Form 2290, file an additional Form 2290 for this vehicle. An additional vehicle may be one that was. bought new or used, or one that was previously owned but just placed in service.

(2) The following information is needed to complete the Form 2290:

• Employer Identification number (EIN);

• Vehicle identification number (VIN) of each vehicle; and

• Taxable gross weight of each vehicle.

(3) The instructions for Form 2290, as well as the Form 2290 itself, provide more

detailed information.

(1) A taxpayer may be eligible to claim a credit or refund of excise tax included in

the price of fuel purchased if the fuel was used in an off-highway business use. The business use may not be for a highway vehicle registered or required to be registered, for use on any public highway. See IRC §§ 4041(b)(1)(C) and 6421(e)(2). The following is a list of a few examples of offhighway business use vehicles:

• Skidders;

• Bulldozers;

• Crawler dozers;

• Road graders;

• Trench diggers;

• Feller bunchers; and

• Harvesters.

(1) Treasury Regulation §§ 48.6421-1(f), 48.6421-7(a),48.6427-1(e), and

48.6427-7(a) list the records used to verify the amount of fuel tax credit or refund due. The following records are required to be maintained by the taxpayer:

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• Number of gallons purchased and used during the period of claim;

• Dates of purchases;

• Names and addresses of suppliers with amounts of fuel purchased from

each during the period of claim;

• Purpose of purchasing the fuel;

• Number of gallons purchased for each purpose; and

• If any of the diesel fuel included in the claim contained visible evidence of

dye, the claimant must attach a detailed explanation to prove that the excise tax was attached to the purchase because dyed diesel fuel is usually sold without the excise tax.

(1) The credit can be claimed on the income tax return through the Form 4136,

Credit for Federal Tax Paid on Fuels. If the credit is at least $750 by the end of a tax year quarter, a claim can be made by filing Form 8849, Claim for Refund of Excise Taxes (Schedule 1, Nontaxable Use of Fuels). A taxpayer may not claim any amounts on Form 4136 that have been claimed on Form 8849.

(2) The fuel tax is considered prepaid, so the taxpayer will be refunded the

amount claimed, even if no tax is due. If a claim for a fuel tax refund is made, and the fuel taxes were included in the deduction for fuel on the income tax return, income must be included in an amount equal to the claim.

(1) Taxpayers may fail to report their total number of trucks on Form 2290,

Heavy Highway Vehicle Use Tax Return, for the Highway Use Tax. During the initial interview, the examiner should ask the taxpayer if any equipment is used off-highway and if so, identify the equipment used. Inspect Forms 2290 and compare the trucks listed to the depreciation schedule. The examiner should also verify that all required vehicles are reported.

(2) To verify the amount of fuel tax credit that must be included in income in the

tax year under examination, inspect the prior year tax return and note the amount of fuel tax credit claimed in the prior year. This is the same amount that must be included in income for the current year.

(3) The proper claimant to claim the fuel tax credit is the end-user. The fuel

supplier is not eligible to file a claim for fuel sold for off-highway business use.

(4) Generally, claims for dyed fuel are not allowable since tax is not included in

dyed fuel.

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(5) If any unusual situations occur in the excise tax area, the examiner may

consult with an Excise Tax Policy Subject Matter Expert.

(1) Historically, provisions for the treatment of reforestation costs change from

time to time so the provisions for the tax year under examination should be reviewed.

(2) In general, reforestation costs play a larger role in planted conifer plantations

than they do in naturally regenerated hardwood stands. However, there are some practices that are used to assist natural regeneration and establishment of hardwoods.

(3) IRC § 194 allows tax deductions for reforestation expenditures, which are the

direct costs incurred to plant or seed for forestation or reforestation purposes. Qualifying expenditures include amounts spent for site preparation, seed or seedlings, and labor and tool costs, including depreciation on equipment used in planting or seeding. Only those costs that must be capitalized and are included in the adjusted basis of the property qualify as reforestation expenditures. Costs that are currently deductible do not qualify.

(4) Under IRC § 194(b), a taxpayer may deduct up to $10,000 ($5,000 for

married couples filing separately) per tax year per qualified timber property for reforestation expenditures incurred. IRC § 194(a) allows a taxpayer to amortize reforestation expenditures (including any amounts remaining after a current year deduction up to $10,000 under IRC § 194(b)) over 84 months. See Notice 2006-47, 2006-1 C.B. 892, for additional details.

(5) The examiner should verify that any costs for which an IRC § 194 election

are made are not included in any timber account (e.g., depletion block) for which depletion is allowed under IRC § 611.

(1) The Federal Government frequently creates programs to share the cost of

tree planting and timber stand improvement with private landowners. The names and funding of these programs can change from year to year. The federal share of these costs depends upon the cost-share rate set in a particular state and county. The maximum cost-share payment that a taxpayer can earn annually is set differently for each program. In addition to the Federal Government, state and certain other government entities also can provide cost share payments. Landowners who receive these cost-share payments may be able to exclude them from gross income for federal income tax purposes per IRC § 126(a).

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(2) For more information about both the amount included in gross income and

the excludable portion on the receipt of a cost-share payment. See the regulations under IRC § 126 and IRS Pub. 225. Note that to be eligible for potential exclusion under IRC § 126, and the cost share payments must meet the requirements in the statute and regulations.

(3) If the taxpayer has been reimbursed under any governmental cost sharing

program, the taxpayer may not deduct these expenses unless the amount reimbursed has been included in income.

(1) Form 1099-S is now required to be issued for lump-sum timber sales. Final

regulations under § 6045 provide guidance regarding the information reporting requirements on sales or exchanges of standing timber for lumpsum payments. This change is in addition to the previously existing requirement for income reporting for pay-as-cut timber sales that qualify under IRC § 631(b). The amendments to Treasury Regulation § 1.6045 apply to sales or exchanges of standing timber for lump-sum-payments completed after May 28, 2009.

(2) More information can be obtained from Internal Revenue Bulletin No. 2009 24, page 1073 or in a current version of 26 CFR 1.6045-4.

(3) A full explanation of who should file a Form 1099-S can be found in the Form

1099-S Instructions.

(1) Christmas trees generally fall under the federal tax provisions for timber

although the tax treatment of some silviculture practices may be different for Christmas trees. See Section VIII, Code and Regulations for more information about Christmas trees.

(1) Examiners need to recognize the need for specialized services of the IRS

early in the audit process to allow a specialized agent as much time as possible for a review and to avoid delaying the closure of the case. The decision to make a referral should be discussed with the Group Manager. Once it is determined that a specialized service is needed, the Examiner will go to the Specialist Referral System Electronic Referral home page and submit a request for a specialist. Some of the most common specialized services needed in the hardwood timber industry are discussed below.

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(1) Engineering services can be very useful in timber valuation and other forestry

issues. The engineering program has foresters that provide these services in groups around the country.

(1) If a large volume of timber records exists and a statistical sample is deemed

useful, the examiner should contact CAS after consultation with his or her Group Manager.

(1) If the examiner can ascertain that the taxpayer under audit is engaged in a

business outside the United States through related affiliates, a referral may be warranted. For example, there is a steady export of hardwood logs to destinations outside the United States including Canada, Asia, and Europe. Examiners may use the Specialist Referral System to obtain assistance.

(1) If unusual problems occur or potential issues have been identified in the

employment tax area, a referral may be made after discussion with the Group Manager. Examiners may use the Specialist Referral System to obtain assistance.

(1) During every examination, it is the examiner's responsibility to consider the

application of penalties if the circumstances so dictate. However, in accordance with IRC § 6751, no penalty will be assessed unless approved in writing by an immediate.

(1) Federal timber tax involves provisions of the Code, regulations, and other

authorities relevant to other industries. However, there are provisions of the Code, regulations and other authorities that deal specifically with timber. Following is a brief, general discussion of some of these authorities. This discussion is not intended to replace research, and a full reading of the items discussed.

(1) All or parts of IRC §§§ 194, 611 and 631 and the Regulations there under

deal specifically with timber. Below is a short description of each provision as it pertains to the timber industry.

(2) IRC § 194 addresses the treatment of reforestation expenditures. Under IRC

§ 194(b), taxpayers may deduct up to $10,000 of reforestation expenditures

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paid or incurred on or after October 22, 2004, for each qualified timber property each tax year. IRC § 194(a) allows the remaining reforestation expenditures in excess of the $10,000 per qualified timber property, or alternately, all reforestation expenditures in a given year, to be amortized over an 84-month period.

(3) IRC § 611 provides an allowance of a deduction for depletion for oil and gas

wells, mines, other natural deposits, and timber. Treasury Regulation § 1.611-1 covers general provisions for depletion of all natural resources. Treasury Regulation § 1.611-3 provides rules applicable to timber. (Note: Treasury Regulation § 1.611-3(a) specifically identifies Christmas trees as falling under the provisions of Treasury Regulation § 1.611-3.)

(4) IRC § 631(a) provides an election for a taxpayer to treat the cutting of the

taxpayer's own timber (for sale or for use in the taxpayer's trade or business) as a sale or exchange. This election generally is referred to as an IRC § 631(a) election and it must be made by the taxpayer on the income tax return for the tax year for which the election is applicable and cannot be made on an amended return for such tax year. (Treasury Regulation § 1.631-1(c)) IRC § 631(a) provides that the election shall apply with respect to all timber that is owned by the taxpayer, or that the taxpayer has a contract right to cut, and is binding on the taxpayer for the tax year for which the election is made and for all subsequent tax years, unless the Commissioner, on showing of undue hardship, permits the taxpayer to revoke the election. Treasury Regulation § 1.631-1(a)(3) provides addition details regarding the conditions under which a revocation may be granted by the Commissioner.

(5) IRC § 631(b) and Treasury Regulation § 1.631-2 provide the tax treatment

for gain or loss upon the disposal of timber under a cutting contract, or any form of contract by which the owner retains an economic interest. This is sometimes referred to an IRC § 631(b) or pay-as-cut sale. This tax treatment does not require the taxpayer to make an election.

(1) For timber revenue rulings and court cases, there is a body of work for

different topics and issues. These areas include basis and depletion allowance, capital gains and losses and like kind exchanges and involuntary conversions. The IRS's treatment of these types of issues can change from time to time and new issues can develop. Research with Westlaw, LexisNexis or other sources may be necessary to find the current position of the IRS regarding these issues. An examiner should contact the IRS Forest Product Subject Matter Expert or an IRS Forester for the IRS's current position.

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(1) In addition to the standard tax return forms, there is an information return

called the Form T. Form T Instructions are currently in a separate document. This form has existed since the beginning of the modern-day income tax and its contents and filing requirements have changed over time. Be sure to check the version of the form and instructions that apply to the tax year(s) you are examining. Currently, not all taxpayers who harvest timber are required to file Form T with their tax return, but all are required to retain the information required by the form.

(2) Report payments of timber royalties made under a pay-as-cut contract and

reportable under IRC § 6050N on Form 1099-S. Also report sales or exchanges of standing timber for lump-sum payments on Form 1099-S.

(3) Sources on the Internal Revenue Service irs.gov web site

• Timber Casualty Loss Audit Technique Guide

• IRM 4.30.2.13 - Field Directive on Timber Casualty Loses

https://irm.web.irs.gov/Part4/Chapter30/Section2/IRM4.30.2.aspx#4.30.2.1 3

• IRS Pub. 510, Excise Taxes

• IRS Pub. 15, Circular E. Employer's Tax Guide

• IRS Form 940, 941, 1099 Instructions

(4) United States Forest Service Web Sites

• https://www.timbertax.org/

• https://www.fs.usda.gov/

• https://data.fs.usda.gov/geodata/state_private/nationaldata.php

(1) Professional Associations

• TAPPI Technical Association of the Pulp and Paper Industry

• AF&PA American Forest and Paper Association

• National Hardwood Lumber Association

• Hardwood Plywood and Veneer Association

(1) Acre - A unit of land comprised of 43,560 square feet.

(2) Annual Ring - A tree's layer of wood growth for one year. Annual rings can

be seen on the cross sections of tree stems or branches.

(3) BF - This is an abbreviation for "board feet."

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(4) BM - This is an abbreviation for "board measure," which usually refers to the

board feet of lumber.

(5) Board Foot - A unit of measurement represented by a board, which is

typically unfinished and unsurfaced, 1-foot-long x 1 foot wide x 1 inch thick. In practice, the working unit is 1,000 board feet, which normally is abbreviated MBF.

(6) Board Foot Log Scale - A unit of measure of the content of a log

determined using a log rule; also, the common unit of measure of timber volume.

(7) Board Foot Green Chain Tally - A unit of measurement represented by

unfinished lumber as it comes from the saw.

(8) Bole - The trunk of a tree, typically where the usable wood is located.

(9) Bolts - Short logs or sections of a large log, usually less than 8 feet long.

(10) Bucking - The process of sawing a felled tree into logs. The length of the

logs is dependent on the species of the tress and the end product.

(11) Butt - The base of a tree or the large end of a log.

(12) CFI - An abbreviation for Continuous Forest Inventory, a system of

periodically monitoring the forest for growth, volume, composition, and mortality of the forest stands.

(13) Carriage - The frame for holding a log while it is being sawed in the mill. The

carriage travels on tracks and transports logs toward the sawline after a cut has been made.

(14) Cherry Picker - A piece of machinery, generally attached to a truck or

loading dock, which is used to load and unload logs.

(15) Clearcutting - A process of removing all merchantable trees from an area in

a logging operation for the purpose of regenerating an even-aged stand.

(16) Conifer - Usually an evergreen tree that bears cones and needle-shaped

leaves. Coniferous trees are known as softwood trees, and softwood lumber is produced from them.

(17) Conversion Costs - Costs of converting standing timber to a saleable

product. Conversion costs include the cost of felling trees, removing limbs, bucking, skidding, loading, and transporting logs.

(18) Cord - A unit of measurement of stacked wood (typically pulpwood). The

standard cord consists of a pile of wood whose pieces are 4 feet long stacked 4 feet high by 8 feet wide, containing 128 cubic feet of space. A long cord is a cord containing wood pieces longer than 4 feet and if 5-foot pieces are used this results in 160 cubic feet of space. A cord is a common unit of measure of timber.

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(19) Core - 1. The inner layer(s) of plywood that is commonly of low-quality

material. 2. The portion of a veneer bolt remaining in the lathe after rotary cutting during veneer production.

(20) Crown - The upper part of a tree, including branches, foliage, etc.

(21) Cruise - A survey of forestland to locate timber and estimate its quantity by

species, products, size, quality, or other characteristics. A cruise should be conducted on the ground and throughout the timber land, not merely on the boundaries or roadsides that border the timber land.

(22) Cutting Cycle - The planned intermission between harvesting operations

within the same stand

(23) DBH - This is an abbreviation for Diameter (of a tree) at Breast Height. The

diameter of a tree is 4½ feet above the ground.

(24) Deciduous - A deciduous tree has broad leaves that it loses in the fall.

(25) Ecology - The science of the relationships between plants and animals and

their environment.

(26) Even-Aged - A term to describe a stand in which the individual trees are

relatively the same age.

(27) Firebreak - A natural or constructed barrier used to stop or check wildfires.

(28) Girdle - To encircle the stem of a living tree with cuts to kill the tree. The

cuts are made to sever the bark and cambium and cause the tree to die by preventing the passage of nutrients. Toxic materials can also be injected into the tree through the cut.

(29) Growing Stock - The total trees in the forest.

(30) Hardwood - Generally trees that have broad leaves such as deciduous

trees. Lumber from hardwood trees is referred to as hardwood lumber.

(31) Head Saw - The main log cutting saw in a sawmill.

(32) Heart Rot - Decay found in the heartwood of trees.

(33) Heartwood - The inner core of a wood stem that is usually darker in color

than the outer sapwood.

(34) Increment Borer - Instrument with a hollow bit, similar to an auger that is

used to extract cores from trees to determine growth, age, etc.

(35) Intolerant Tree - A tree incapable of growing in the shade or in competition

with other trees.

(36) Kiln Dry - A process of drying lumber by the controlled application of heat.

(37) Log - 1. A verb meaning to cut and deliver logs. 2. A noun meaning a

segment of a tree

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(38) Log Deck - 1. An area or platform on which logs are placed. 2. A pile of

logs. 3. A portion of a sawmill on which logs are held before they are sawed.

(39) Log Rule - A method of estimating the amount of lumber that can be sawed

from trees or logs. One must know the log's length and diameter to use a log rule. The three most common log rules are Doyle, International ¼ and Scribner.

(40) MBF - An abbreviation for 1,000 board feet, which is the working unit for

measuring volumes of wood

(41) Marking - The process of identifying trees with paint or ribbon that are to be

cut and sold.

(42) Mixed Stand - A stand in which less than a specified percentage of trees

forming the main crown canopy consist of a single species.

(43) Old Growth - Also known as first growth timber or virgin timber. It refers to a

forest in which little, if any, cutting has been done and that has not suffered large disturbances.

(44) Overcut - The excess of the quantity of timber cut from a tract over the

estimated quantity on the tract.

(45) Overrun - The excess of the lumber sawn from logs over the quantity

estimated that could be sawn.

(46) Overstory - Refers to trees in a stand forming the upper crown cover.

(47) Peeler - The log used in the manufacture of rotary-cut veneer.

(48) Pulpwood - Wood cut primarily to make wood pulp for manufacture into

paper, fiber, paperboard, etc.

(49) Pure Stand - A stand in which at least a specified percentage of trees

forming the main crown canopy is of a single species.

(50) Rotation Age - Age at which a stand is considered ready for harvest under

a management plan.

(51) Reforestation - The natural or artificial activities used to replenish an area

with forest trees.

(52) Release Cutting - The process of cutting large poorly formed or diseased

trees that overshadow smaller, healthier trees to allow the younger trees to grow.

(53) Regenerate - The natural or artificial process of renewing a forest by direct

seeding or planting, including through self-sown seeds, sprouts, etc.

(54) Regeneration - The young trees that result from regenerating a site.

(55) Sapling - A young tree 2 to 4 inches DBH

(56) Sapwood - The light-colored outer ring of wood in a tree. It consists of living

cells, and it is necessary to conduct water and minerals to the tree crown.

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(57) Sawtimber - Trees from which sawlogs may be cut. Sawtimber stands

generally are stands where sawtimber-sized trees are the most important component.

(58) Sawyer - The person who controls the sawing of sawlogs into lumber.

(59) Scale - The person who determines the volume of logs.

(60) Scaling - The process of determining the volume of logs. Measuring the

dimensions of the logs is part of the process.

(61) Second-Growth - New timber that develops after removing old growth by

harvest, cutting, fire, or other causes.

(62) Section - A unit of land measurement generally equaling one mile square or

640 acres.

(63) Seedling - A young tree grown from seed that is smaller than a sapling.

(64) Seed Tree - A tree that produces seed and is often left during logging for

reforestation.

(65) Selective Logging or Cutting - The selective removal of a single tree or

small groups of trees during a timber harvesting operation. These trees may be removed because they are mature, large, or diseased.

(66) Severance Tax - A state excise tax levied on timber cut.

(67) Site - An area generally chosen for its ecological factors and ability to

produce timber.

(68) Skidder - A four wheeled or other self-propelled machine that is used to skid

felled trees or logs. Also, one who skids logs.

(69) Skidding - The yarding of trees or logs by pulling or towing them across the

ground.

(70) Slash - The woody debris remaining on the ground after logging, including

branches, bark, chunks, cull logs, uprooted stumps, and uprooted trees.

(71) Softwood - Generally trees that have needle or scale like leaves such as

conifers.

(72) Stand - An aggregation of trees occupying a specific area of land and

sufficiently uniform in species, composition, age, density, and other conditions to be easily distinguishable from the forest or other growth on adjoining areas.

(73) Stumpage - Standing timber or the price paid for such timber.

(74) Sustained Yield - The quantity of timber a forest can produce continuously

under a given plan of management with a balance between growth and harvest.

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(75) Thinning - A cut in an immature stand performed to increase the growth

rate and quality of growth on remaining trees, to improve yield, and to recover usable materials.

(76) Timber - For federal tax purposes, the wood in standing trees that is

available and suitable for exploitation and use by the forest industries.

(77) Timber Stand Improvement (TSI) - A term generally applied to

intermediate cuttings and other cultural treatments done to improve stand conditions in a stand that are not part of a major harvest.

(78) Underrun - A descriptive term indicating the amount by which lumber sawn

from logs is less than the estimated quantity expected to be sawn.

(79) Understory - Trees in a stand that grow under the trees forming the main

crown canopy.

(80) Uneven-Aged - A term to describe a stand in which there are significant

differences in the age of the trees and three or more age classes exist.

(81) Weed Tree - A tree with little value, if any.

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