Timber Tax Advice

Securities brokers are required to report to the IRS and their customers the basis of customers’ securities sold during the tax year. Form 1099-B is used. This applies to securities acquired after 2010. Obviously this has no direct impact on the reporting of timber sales, but it did necessitate changes in Schedule D – Capital Gains and Losses. The change will allow IRS computers to match the basis reported on Schedule D, actually new Form 8949, with the basis reported by the securities brokers.

Schedule D is used to report the outright sale of timber on the stump for a lump-sum amount when the timber is not a business asset in the hands of the owner, or notsold in a cut form with an election in effect to treat the cutting as a sale under Internal Revenue Code Section 631(a).  If the timber is a business asset at the time of disposal the gain or loss is reported on Form 4797, as before. Form 4797 is unchanged. Gains and losses are netted on Form 4797 and net amounts transferred to Schedule D. The new Form 8949 is not used in conjunction with Form 4797.

When you read the instructions for Schedule D they will refer to gains and losses on “capital assets.”  These are assets NOT held for use in a trade or business, or primarily for sale to customers in the ordinary course of a trade or business.

The new Schedule D does not include lines to report the sale of each asset. Instead, these details are reported on Form 8949. This form starts with boxes to be checked as follows: Part I – Short-Term Capital Gains and Losses - (A) Short-term transactions reported on Form 1099-B with basis reported to the IRS; (B) Short-term transactions reported on Form 1099-B but basis not reported to the IRS; (C) Short-term transactions for which you cannot check box A or B.  The second page of Form 8949 is Part II – Long-Term Capital Gains and Losses with the same three boxes.  A separate Form 8949 must be submitted for each of the Part I boxes (A), (B), or (C), and Part II boxes (A), (B), or (C). Thus, an active investor could need to file six Forms 8949 with their Schedule D.

The columns on Form 8949, Part I and II are similar to those on the old Schedule D, but two new ones have been added. These are the columns:

3(a) – Description of property (Example 100 sh. XYZ Co.)
3(b) – Code, if any, for column (g) [this is a new column]
3(c) – Date acquired (Mo, day, yr.)
3(d) – Date sold (Mo., day, yr.)
3(e) – Sales price (see instructions)
3(f) – Cost or other basis (see instructions)
3(g) – Adjustments to gain or loss, if any

If you sell stumpage that you own directly, not through a REIT or other business form, the basis will not be reported to the IRS on a Form 1099-B. Thus, you would check box (C) on Part I or II.  If you held the timber for more than one year prior to sale it’s long term and Part Ii is used. The columns used would be (a), (c), (d), (e), and (f). The allowable basis (depletion allowance) and sale expenses are added together and reported in column (f). This is exactly the same as on the old Schedule D. Of course, you should also complete for your records Form T, Parts II and III. AND, you should have in your permanent records the documentation for the basis of your timber and for the sale as reported on Form 8949.

If you haven’t established a basis in your timber you still use Form 8949, but in column (f) you report just your sale expenses, if any. You do not need to have a basis in your timber to report it as a capital gain. It’s of course not possible to have a capital loss without a basis. On a related point, it’s also not possible to report a casualty loss to timber without having a basis to compare to the change in fair market value.

Although not applicable to timber sales, I’ll briefly explain the purposes of the columns (b) and (g) on Form 8949. On page D-10 of the instructions for Schedule D there’s a table that lists the possible reasons that the basis reported on the Form 1099-B or 1099-S you received from your broker is incorrect. In column (b) you enter the letter associated with the type of mistake, and in column (g) you enter the amount of the adjustment needed to result in the correct gain or loss. So, the computer looks for a match between the Form 1099 and the entry in column (f), then adjustments are reported separately. Adjustments are of course subject to audit.

William L. Hoover, PhD

Estate and Gift Tax Values

The IRS has announced that the unified credit exclusion amount will be $5,120,000 for the estates of individuals dying in 2012. This is the amount of combined value of assets included in the estate and taxable gifts.

The annual gift tax exclusion will remain at $13,000 for gifts by an individual to any number of donees. There was no increase because the total amount of inflation since the previous increase to $13,000 did not result in a minimum $1,000 increase.

The maximum amount by which a special use valuation election for a 2012 estate can reduce the property subject to the election is $1,040,000. The applicable Code is 2032A.

Income Tax

Standard deduction: Single taxpayers – increased to $5,950 from $5,800 in 2011. Married filing jointly – increased to $11,900 from $11,600 in 2011. Heads of households –increased to $8,700 from $8,500 in 2011. Married filing separately – increased to $5,950 from $5,800 in 2011.

Personal exemption: Increases by $100 to $3,800.

Social Security Wage Base: For 2012 the social security wage base will be $110,000. Wages above this amount will not be subject to the FICA tax. This means that both the employer and employee will pay $6,826.20 in FICA tax. There is no limit on the amount subject to the hospital tax. Remember that capital gains are not subject to either the FICA or hospital tax, and that except in very rare circumstances income from the disposal of timber qualifies as a capital gain.

William L. Hoover, PhD

The IRS has initiated an investigation of donors of property to non-spouse family members for less than full consideration, i.e. fair market value. Audits are being made to determine if gift tax returns were filed for transfers of interests exceeding the annual gift tax exclusion of $13,000 per donor per donee. The audits are based on information from state and county records in Connecticut, Florida, Hawaii, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Tennessee, Texas, Virginia, Washington and Wisconsin. Since real estate transfers must be recorded in county records it’s quite likely that transfers of forest land will be subject to the cross matching. It’s not clear how the IRS will assign a fair market value to the land transferred, but all that’s needed are rough approximations. California is fighting the request from the IRS for transfer records.  Records from additional states will be sought. News reports indicate that the IRS has conducted 323 audits as of the end of May and 500 more will be forthcoming.

William L. Hoover, PhD

The commonly accepted statute of limitation for a tax return is 3-years after the date the tax return was due, even if filed before this date. For example, for a tax return filed in March of a given year, the period starts on April 15 of that year, or other due date. There are different rules for partnerships and other pass-through entities that provide partners with items of taxable income or losses. In the case of criminal intent there is no statute of limitation.

The 7^th Circuit Court of Appeals overturned a ruling by the Tax Court that an overstatement of basis is not an omission of gross income triggering a six-year statute of limitation under Code Sec. 6501(e)(1)(A). [ Beard, Kenneth, 107 AFTR 2d 2011-552, 01/26/2011, reversing TC Memo 2009-184] This case dealt with a Son of BOSS short-sale strategy, but the ruling could be more broadly applied, at least in the 7^th Circuit.

It’s likely that a majority of sales of timber by family forest owners underestimate the basis of the timber disposed of, resulting in a higher taxable gain. We have, however, had discussions with owners seeking to increase the basis in their timber above that on their books. Their proposed strategy is usually to increase the value of the property as a whole for stepped-up-bases, and to reduce the fair market value of the land relative to that of the timber. There are restrictions on such reevaluations. The Beard ruling should give further pause to aggressive revaluations.