With the exception of property taxes, non-capital expenses for the management of forest land are deductible only if the taxpayer has a profit motive. Profit is broadly defined to include appreciation in the value of assets, including timber and land. Increases in these values is how many forest landowners show their intention to make a profit.
Forest landowners are frequently required or requested to incur costs primarily to improve the environment, not their profit. Many make improvements because they believe that it’s the right thing to do. These activities frequently reduce income potential, rather than increase it, as well as requiring cash expenditures. Examples are restoration of natural ecosystems, such as wetlands, and improving habitat for non-game wildlife. Activities that improve habitat for game species, for which hunting fees are charged, are treated like any other for-profit enterprise.
Operating expenses are deductible when the activity paid for is “ordinary,” “necessary,” “reasonable in amount,” and “directly related to the production of income.” Ordinary means broadly accepted by the industry, a standard practice within the industry. Necessary means that the enterprise would not be as successful without the action. Reasonable in amount means that the operator made an effort to carry out the activity with as little cost as possible. Directly related to the production of income means that the activity increases the quality and/or quantity of the product produced. Pre-commercial thinning of pine stands, maintenance of firebreaks, protection of young hardwood stands from deer browsing, and other protection measures meet these four criteria.
But, what about activities with direct costs or reduced income potential. Leaving stands to mature for Red Cockaded woodpecker habitat, bald eagle nesting trees and buffer, and riparian buffers are examples. Is the lost production simply the cost of doing business? Or, is a public benefit provided for which some form of compensation should be available?
In an earlier editorial we took a position in favor of tax simplification. But, if the Internal Revenue Code (Code) continues to be used to provide incentives for various industries to make environmental improvements, forest landowners should have a stake. Incentives for most industries are in the form of tax credits or accelerated depreciation. The Code has not been used to offset the direct and indirect costs for forest landowners to make required or voluntary environmental improvements. The Federal focus has been cost-share programs, primarily through the Natural Resources Conservation Service -- Farm Services Agency, US Forest Service and some states. These are good programs when administered efficiently and equitably, but restricted by annual budget allocations.
Mark Koontz, a Purdue graduate student at the time, looked at ways to modify the Code to provide environmental incentives to complement cost share programs. (See Financial Incentives to Promote Environmental Management by Nonindustrial Private Forestland Owners.” MS Thesis, Purdue University, May 1999, 102 p.) The possibilities include expanding the reforestation tax credit and adjusting amortization to include environmental expenditures whether or not planting is for commercial timber production, create an entirely new authority for a conservation credit and amortization, authorize outright deductions (even if the activity won’t make a profit), provide timberland owners with a choice between a cost share payment or tax deduction for qualified expenditures, or treat qualified expenditures as a charitable contribution through a well established conservation organization. You of course noticed our frequent use of the word “qualified.”
Federal income tax system is self-assessed, subject to audit. For practices that are universally accepted as beneficial, there is no reason that Congress couldn’t specify these and use the IRS audit process to verify compliance. Other possibilities include allowing federal and state agencies to authorize what qualifies in a given state. This is how cost-share programs are handled. Koontz also suggests considering the use of private conservation organizations such as The Nature Conservancy or local land trusts that employ natural resource professionals and are knowledgeable about environmental needs in their operating areas.
The dramatic changes we’ve seen in the demands placed on private lands call for creative thinking to inspire institutional adjustments. Our market economy, based on private property rights, has served us well. Forest landowners will continue to do what’s right with the proper incentives. But, asking them to bear an increasing portion of the cost of environmental services without reasonable compensation is inconsistent with the historical basis of the American economy. Let’s work with the environmental community to get the incentives needed to provide both timber resources and environmental services through incentives, not regulatory disincentives.