Generally
Forest land has many new roles in our economy. Recognition of the environmental services provided is reflected in payments for carbon sequestration[1] and watershed services,[2] among others. The use of conservation easements is expanding to include these additional goals.
As with any new economic activity existing contract and tax law applies unless modified by legislation, the courts, or rulings of the IRS or state revenue agencies. When there is established authority for the treatment of specific transactions, we cite the authority in our discussion. If there are none we present relevant considerations and possible applications of existing law.
The first program providing rental payments for the provision of environmental services was most likely the Conservation Reserve Program administered by the Natural Resources Conservation Service (NRCS), an agency of the U.S. Department of Agriculture. NRCS programs have expanded to include wetlands, riparian areas, and wildlife habitat. They were expanded further by the 2008 Farm Bill and the establishment of the Office of Ecosystem Services and Markets. Many private conservation organizations and state natural resource departments also have programs.
The major private-sector market-based activity is the buying and selling of carbon credit units on exchanges such as the Chicago Climate Exchange (CCX), The Green Exchange (NYMEX), Canadian Climate Exchange (CCE), and Montreal Climate Exchange (MCeX)
NRCS Conservation Programs
Payments provided to landowners to install conservation practices are taxable income, unless excluded, as discussed in Chapter 6. Annual rental payments under the Conservation Reserve Programare ordinary income since they are not received for the disposal of an asset. In addition, they are subject to the self-employment tax. However, payments received after 2007 by individuals receiving social security retirement or disability payments are not subject to the self-employment tax.[3] If payments are for granting a perpetual conservation easement, such as under the Wetlands Reserve Program, a capital gain has been realized. Granting a non-perpetual easement is not a disposal and ordinary income is realized.
Payments for Sequestering Carbon Credit
The carbon creditmarket is relatively new and seeking growth opportunities as the U.S. Congress continues to debate the appropriate vehicle for control of carbon emissions. The 2009 Copenhagen Round of multilateral discussions did little to advance U.S. policy development. Nevertheless, carbon credits have been and will continue to be sold by forest landowners as an alternative source of income.
The IRS has provided no specific guidance on how payments for carbon credits should be handled and it is unlikely that from forest landowners’ perspective any are needed for the basic transactions involved. Nevertheless, since this is a new area of tax law we recommend that forest landowners use their personal tax and legal advisors to determine the treatment in their specific circumstances. A documented analysis of a taxpayer’s situation should be developed and retained in their files.[4] Our discussion is our assessment of how the Code applies, not legal advice.
Conservation Easements
We will be referring to conservation easementsin the following discussion. They are a contract that results in the disposal of a partial interest in real property.[5] It limits the rights of the landowner to do something that they would otherwise have the right to do on their land. Conservation easements, as with contract law generally, are instruments under the statutory law of the state in which the real estate is located.[6] These contracts are valid under state law only if they advance one of the conservation purposes enumerated in statute.[7] “Enhancing air quality” is one such listed purpose, however, when the Uniform Conservation Easement Act was drafted and adopted by states, carbon credit markets did not exist. Pending our knowledge of a different interpretation or state court cases indicating otherwise, we assume that a contract drafted solely to transfer a specified tonnage of carbon sequestration rights in perpetuity with the associated restrictions on the timber severance rights of the landowner, would not qualify as a conservation easement.
In some cases the rights to receive payment for environmental services, including carbon credits, are included within the framework of a conservation easement established for other purposes. In other cases a conservation easement is included as part of the carbon credit program to guarantee that a specified quantity of timber is sequestered in perpetuity. [8] Such a guarantee is required by at least one state for carbon sequestration contracts to be valid.[9] The use of a conservation easement to guarantee sequestration in perpetuity is demonstrated in Examples 8-1 and 8-3.
Two Market Components of the Right to Sell Carbon Credits
The existence of the carbon credit market has added a new stick in the bundle of rights associated with the ownership of timber. It is one of the few for timber in place (in situ). Others include the right to tap trees for sap, cut branches for decorative uses, strip outer bark for extraction of herbal medicines, and gather moss growing on trees. Leasing for the collection of such products started many years ago. These rights are generally leased for one season or a few years. The rent received by the owner of the leased timber is ordinary income.
The carbon credit market is different in terms of the length of the contracts and constraints placed on the timber owner. These contracts require forest landowners to at least retain a specified volume of timber, and more commonly to sequester carbon not currently being sequestered by growing additional timber. A third party verification system with on-site inspections and imposition of costs for default are a compliance mechanism. Another is the use of an additional level of constraint, such as conservation easements, demonstrated in Example 8-1.
Example 8-1. The Jones are negotiating with a local land trust the cash sale of a conservation easement in perpetuity[10] on their forest land in New York state. The parties have agreed that the Jones must maintain in perpetuity a specified volume of timber of a specified species mix. The stumpage value of this volume of timber is included in the appraisal of the land used and is a subject in the negotiation of the price of the easement. The parties agree that the stumpage value is the price that would be received for the timber if purchased to be severed by the buyer. The current species mix includes a large number of hard maple trees that could be tapped for maple syrup production. The Jones don’t tap these trees themselves. Thus, an additional factor in the appraisal is who will have the right to tap the trees under the easement, the landowner, or the land trust. In addition, the right to sell carbon credits is part of the negotiations. The parties agreed that since the Jones’ reside on the property they will retain taping rights. The Jones consult their professional forester who is assisting with the appraisal. He estimates the capital value[11] of the timber for carbon credits. The Jones decide and the land trust agrees that since under the easement the Jones will be responsible for managing the timber it makes sense for the Jones to retain all carbon credit rights. Thus, the appraised market value of the easement doesn’t include the capital value of the right to sell carbon credits.
This example demonstrates that the right to sell carbon credits has value in-and-of-itself and should be factored into the determination of the fair market value of timber and the associated forest land. [12] We do not know of any carbon rights brokers operating in the U.S., but this market may develop independently from conservation easements when the market price of carbon credits increases substantially.
Sale of “Carbon Credits" – A straight-forward sale of carbon creditsis demonstrated in Example 8-2. Forestry carbon credit contracts vary depending on the protocol, registry and market (e.g. regulated vs. voluntary) the aggregator is selling credits to. A majority of the contracts are similar in principle and form. Most of the contracts sold on the Chicago Climate Exchange (CCX) are those of aggregating companies that buy carbon credits from forest landowners. The owners of large acreages of forest land may, however, may not need to aggregate their lands with those of other owners. An aggregator is an organization that accumulates a large enough bundle of carbon contracts that in total the minimum tonnage requirement for a tradable unit is met. The base amount of the payments received by forest landowners is determined by the actual sale price of the unit. The tax treatment is determined by the terms of the contract between the landowner and the aggregator.
Example 8-2. The Hostetlers’ 740 acre farm includes a 60[13] acre field no longer grazed or cropped. After a web-search they identify a company that serves as an aggregator of carbon sequestration contracts that they sell on one of the major carbon exchanges. The aggregator’s representative for their region visits their farm and explains the options available. They select the reforestation option for the 60 acres since this maximizes the tons of carbon captured and thus the annual payments received.
After contacting the Natural Resources Conservation Service (NRCS) office for their county theylearn that since the 60 acres is located adjacent to a waterway that floods periodically they qualify for cost-share payments for tree planting. They also qualify for a 30-year or perpetual conservation easement, but they decide not to apply under this NRCS program. They contract with a consulting forester who provides tree planting services, including two seasons of follow-up weed control. They treat the cost-share payments and tree planting and maintenance expenses using the tax rules applicable to timber production.
The aggregator’s representative returns the year after the trees were planted and approves the project. They execute a contract under which the Hostetlers agree to maintain the plantation for 15 years according to guidelines specified by the aggregator. Under the contract they will receive 15 annual payments with each payment determined by the pre-established increasing amount of carbon sequestered each year, subject to verification. At the end of the 15 years all rights to the plantation revert to the Hostetlers.
Under these provisions the aggregator has obtained a leasehold interest in the 60 acres of land and trees. The Hostetlers’ farm is structured as an LLC and they file as a partnership on Form 1065. They report the annual payments as rental income on line 13.
Although the contracts between forest landowners and an aggregator do not use the language typically associated with leasehold interests in real property, the end result is the same. The landowner is contractually obligated to maintain and/or increase forest carbon stocks by continuing to grow and manage a designated mix of tree species according to standardized management practices on a defined area of land for a specified period of time. Most contracts are for trees planted on land that was not forested prior to afforestation, or was a highly degraded forest. The forest owner retains title to the land and the trees under contract, and is obligated to provide the management and cover the costs necessary for the trees to grow as projected. In legal terms these contracts in effect establish a “negative servitude” in real property for a specified period of time. A negative servitude is simply an obligation for the owner of real property not to do something on their own land, in this case not decrease forest carbon stocks below a specified level. Under the terms of carbon credit sale contracts the aggregator or their third party representative has the right to enter the property to verify that the terms of the contract are met. The third party, referred to as an “independent verifier,” is frequently a consulting forestry company under contract to the aggregator.
Under this contractual relationship the forest owner has not made an disposal of real property, but has in effect leased trees for a designated period of time and remains personally responsible for the management of the property. Thus, the tax treatment is that applicable to rental property, trees in a forest complex in this case. Since there is no disposal, capital gainstreatment doesn’t apply.
Tax treatment of rental property – The tax treatment of rental property is discussed in Chapters 2 and 3. Rental payments are ordinary income reported on Form 1040, Schedule E for individuals that hold the property to realize a profit. Otherwise the rental income is reported on Form 1040 line 21 and expenses are subject to the hobby loss rules,[14] deductible only up to the amount of rental income received. The expenses are miscellaneous itemized deductions. Individual owners renting for the production of income at a profit report income and expenses on Form 1040, Schedule E. Businesses with incidental rental income report it on their business tax return. Costs of acquisition and major repairs are capital and recovered by depreciation or amortization in the case of improvements made by lessees. The costs of maintenance and provision of services associated with the rental activity are deductible against rental income.
Application of rental rules to “sale” of carbon credits – In Example 8-2 the carbon sequestration payments were incidental to the Hostetlers’ farm business. In other circumstances payments may lead to the establishment of a separate rental activity. If the production of timber for eventual commercial sale or use in an affiliated business remains the primary purpose of the overall activity, it’s unlikely that it would be considered by the IRS to have been converted to primarily a rental activity because of a carbon credit contract. The terms of a carbon sequestration contract also should not negate qualifying for the reforestation deduction and amortization provisions of the IRC.[15] Carbon contracts require that the timber be managed in a sustainable manner. This should allow the owner to manage the timber in a manner consistent with accepted industry practices, including thinnings to maximize the growth of crop trees under a management plan based on the generation of an eventual profit from the overall activity. Unless the length of a carbon contract extends the rotation age for the timber beyond an age at which it is no longer of any commercial value, it can be planted with the intent of eventual commercial sale or harvesting for use in the business of the owner as required by IRC Sec. 194.[16]
Thus, for a well established timber production business a carbon sequestration contract should not change the structure of the business. This might not be the case if the pre-contract activity does not qualifying as a business or for-profit investment activity. Consider the case of the Perkins in Example 8-3.
Example 8-3. The Perkins own a 120 acre tract of poorly stocked forest land. They purchased it three years ago from a seller who liquidated the merchantable timber just before the land was sold. They built their primary residence on the tract but otherwise did nothing other than clear trails for nature walks. They heard about the potential for receiving payments for carbon sequestration from a neighbor and found out that they could qualify if they made improvements in their woodland by releasing advanced regeneration and doing enrichment plantings in areas without adequate regeneration.
They signed a contract with the representative of an aggregating company. The contract required that they make specified timber stand improvements and plantings within one year. Payments started the next year similar to Example 8-1 and were to continue for 20 years. At the end of the contract all rights to the timber will revert to the Perkins. Since they did not have an existing business or investment activity associated with the tract, the contract resulted in the establishment of a rental activity.
The Perkins reported rental payments and expenses on Form 1040, Schedule E, Part I. Since the woodland was in rented 365 days per year they checked “no” for the question on line 2 of Part I.
The terms of a carbon sequestration contract also should not negate a landowner from qualifying for the reforestation expensededuction and amortization provisions under Code §194, discussed in Chapter 4. Most aggregating companies include in their contracts a provision that the timber be managed in a sustainable manner. This may mean having the forest land certified by one of the certification program, such as the Sustainable Forestry Initiative or Forest Stewardship Council. These programs allow a forest landowner to manage the timber in a manner consistent with accepted practices, including thinnings to maximize the growth of crop trees under a management plan based on the generation of an eventual profit from the overall enterprise. Unless the length of the contract substantially extends the rotation age for the timber or does not permit sustainable harvesting, it’s also unlikely that the IRS would take the position that the timber is not being held for eventual commercial sale or use.[17]
Annual carbon credit payments received from an aggregator are net of the fees taken off the top by the aggregator and the exchange used to sell the credits. Since these fees do not pass through the books of the forest owner, only the amount actually received would be reported as ordinary income on the business’ tax return or as other income on Form 1040 if the activity is treated as an investment for tax purposes. If otherwise treated as a rental activity, as in the case of land leased to a hunt club, the net payments would be reported on Schedule E of Form 1040.
Treatment of upfront costs – A remaining issue is the treatment of upfront costs incurred by landowners entering into carbon contracts. These might include consultant’s fees to provide timber inventory data, other information required for certification, development of a management plan, and legal fees. These costs are capital in nature and should be amortized over the life of the carbon contract. However, if the amount of these costs is incidental to the total cost of operations for the business, deducting them currently may be acceptable under the so-called de minimus principle. Also, if these expenditures would have been made even if the carbon contract was not involved they may be treated as they would have been otherwise.[18]
Sale of Carbon Credit Rights – Carbon credit rightsattach to timber which in turn attaches to the land. If land with timber is disposed of the carbon credits rights transfer with it, unless specifically retained under the terms of the contract. In Example 8-1, if the Jones had sold carbon credits rights along with the conservation easement they would have received capital gains treatment on the sale of these rights along with the sale of the conservation easement. Capital gainstreatment is received for carbon credit rights to the extent that the sale price for the easement is higher than if the carbon rights had not been transferred with the easement. The assumption is that the sale of the easement qualifies for capital gains treatment under Code §1221 or 1231.
More Complicated Example- Example 8-4 describes a more complicated set of circumstances.
Example 8-4. Ruth Franklin has owned for 10 years 1,200 acres of west coast Douglas fir forest land. The entire acreage is stocked with timber, but the volume is well below the level recommended for commercial timber production. The land lies within the City of DuBois’ watershed. The city has an active watershed protection and management program that includes the purchase of conservation easements on private lands, but they have had difficulty attracting private landowners to the program. The City Forester, Bob Franklin, decides to work with one of the major carbon aggregators operating in his region to combine the purchase of easements with the sale of carbon sequestration credits to make the program more financially attractive.
Bob worked over 8 months with Ruth to develop an acceptable contract. The sticking point was whether the 30-year stream of carbon payments would (1) be capitalized into the price paid for the conservation easement with carbon sequestration rights held in perpetuity by the city; (2) would be paid annually to her directly by the aggregator under a contract between Ruth and the aggregator, or (3) Ruth would retain carbon sequestration rights but authorize the city to execute a carbon contract for no more than 30 years and pay Ruth a specified percentage of carbon payments.
The conservation easement in perpetuity was negotiated with the needs of both the city and the aggregator considered. The city’s primary concern was maintaining adequate forest cover and implementation of best management practices to minimize the export off-site of soil and pesticides. This also meant restricting all development of the land for any purpose other than those necessary for timber management and harvesting operations. The aggregator’s primary interest was securely locking up carbon for the 30 year contract period.
The resulting conservation easement with the City of Dubois specified that all forestry activity must be approved by the city forester, that averaged over a 3-year period the total volume of the specified species of timber not drop below the current level, and that any timber harvesting be conducted using even-aged cutting blocks not exceeding 5 acres. The contract also identified areas excluded from all harvesting because of high erosion potential. This contract contained no provision regarding carbon offsets on the existing or additional volume of timber. The contract incorporated a detailed inventory of timber and recommended forest management practices prepared by a major forestry consulting firm. The price paid for the conservation easement included the current fair market value of the volume of timber that must be maintained on the property.
A carbon contract was executed between Ruth and the aggregator. It incorporated by reference all the forestry provisions of the conservation easement, but further specified that the current stocking level be increased by 150 percent and be maintained at that level until the end of the 30-year carbon contract. Ruth will receive annually the contracted rate for the additional tonnage grown, but no payment for carbon in excess of the 150 percent stocking level of the specified species.
Ruth was allowed under the terms of both contracts to harvest, subject to approval of the city forester, any volume accumulated in excess of 150 percent of current volume.
The two contracts in Example 8-4 require the tax treatment of each to be assessed separately.
Ruth’s sale of the conservation easement constituted a disposal of the development rights and the current volume of timber.[19] Since this contract did not dispose of the right to sell carbon credits Ruth retained this right for the existing volume of timber and any additional volume added by growth.[20] This assumes that the qualified before-and-after appraisal used to negotiate the sales price of the easement incorporated the young growth and merchantable timber. The taxable gain is the amount paid, less sale expenses, less the allocated basis of the land and the allowable basis for volume of merchantable timber disposed of, even though this volume will not be severed.[21] A disposal of timber has occurred because Ruth relinquished all rights to any economic gain from the severance of this volume of timber.[22] This gain would be reported as a long-term capital gain.
We now consider the tax treatment of the carbon credit contract. The payments are for the additional volume to be grown over this period. Since this volume didn’t exist at the time the conservation easement was executed, it could not be have been disposed of[23] and capital gains treatment doesn’t apply. The aggregator has in effect rented rights in the existing volume of timber to grow additional timber. The argument could be made that the City of Dubois should receive payment for this right.[24] Thus, the annual payments for the carbon sequestered by the additional timber grown are rent reported as ordinary income. Payment(s) constitute rent for use of the timber.
Long-Term Timber Contracts
The body of law dealing with long-term contractsfor cutting rights in timber reflect the economic value of timber prevailing in the 1950’s and 60’s, i.e. severance for processing into wood-based products. The well established tax treatment is that payments not to exceed the fair market value of timber existing on the date of the contract may qualify for capital gains treatment under the provisions of Sec. 1221 or 1231. Payments in excess of the fair market value on the date of the contract represent rent for the use of the land and/or growing stock to grow additional timber.[25] These contracts were typically for 30 to 60 year periods. Many required that timber management and harvest scheduling be conducted to guarantee that at the end of the contracted period a specified volume of timber be present. Otherwise lessees were not required to maintain a specified volume of timber earlier in the contract period.
Given that in most states leases on real property can run for up to 99 years, the possibility arises of entrepreneurial activities by third parties who execute long-term leases to generate revenue from timber harvesting and/or a sequence of carbon sequestration contracts.[26] This potential is demonstrated in Example 8-5.
Example 8-5. The Stewart Corporation is a national forestry consulting company that also invests in timberland for its own account, and for the development of timber real estate investment trusts (REIT). They have sold carbon credits on their own land and assist clients to do likewise. Based on their expertise in timber management and marketing, and good relations with many business clients owning large tracts of forest land, they are considering the profit potential from long-term leases of timberland. Their business plan includes these provisions.
Stewart negotiates lease terms with landowners and aggregators to provide maximum flexibility in balancing the volume of timber that needs to be cut to meet the required minimum rental payments, and the volume sequestered under carbon credit contracts. Landowners (lessor) are paid a fixed annual rent per acre adjusted for inflation. Stewart generates the revenue to pay the rent, cover expenses, and their profit margin by harvesting the timber existing at the start of the lease and from additional timber grown during the life of the lease. They generated additional income from the sale of carbon credits and hunting leases. Stewart and landowners negotiate the rent based on projections of these income flows.
The tax attorney advises the board of directors that a Form 1099 must be submitted to landowners (lessor) annually reporting the rent paid. The landowner reports as capital gains the rent received and each year adds the rent to the total received to date. [27] In the year that the total equals the fair market value of the timber on the date of the contract, any additional amount of rent is reported as ordinary rental income.
Sale of carbon contracts on a secondary market - Someone that has an existing contract right to receive a stream of payments can sell this contract for a lump-sum amount if a secondary marketexists and the contract does not restrict doing so. The contract is reassigned to the buyer and future payments go to the new owner. This is the basis of the secondary mortgage market, and the market for rights to the payments to be received by lottery winners. Forest owners “stuck” with a periodic payment contract subject to ordinary income tax treatment might want to sell it if allowed under the original contract. The sales price would be the market-based present value of the stream of future payments. Under some circumstances this sale might convert ordinary income into a capital gain.
Capital gains treatment doesn’t apply to such a sale by a lottery winner. The so-called “substitute for ordinary income doctrine” applies. This doctrine is based on case law, not legislation. Thus it is not entirely settled, but the courts’ analyses provide a firm foundation for assessing the circumstances under which capital gains treatment for sale of a carbon payments contract might apply. The key most likely will be the continuing role of the forest owner in management of the land and timber. A lottery winner’s right’s to payments carries no further obligation once he is declared the winner. One of the courts put it this way - assets that constitute a right to earn income qualify for capital gains treatment, while assets that constitute a right to earned income merit ordinary income treatment.[28] Thus, the “substitute for ordinary income doctrine” should not apply to lump-sum contracts requiring a forest owner’s continued management of the land and timber under contract. If the contract relieved a forest owner of all further management obligations other than maintaining title to the land the doctrine most likely would apply resulting in ordinary income tax treatment.
Expanding to Below Ground
Carbon markets currently deal with the more easily measured above ground portion of trees. The tonnage stored below ground may be at least as great as that above ground. Once standardized measurement techniques are developed for below-groundcarbon root tonnage may be included in contracts. Current tax law applies only to above ground portions of trees, to “timber.” Would tax law applicable to “timber” as traditionally defined be extended to roots? The only ruling on the below ground portion of trees deals with the now antiquated practice of pulling southern pine stumps after a harvest.[29]
Need for Tax Basis of Carbon Credit Rights
If carbon credit rights became a factor in the appraisal of forest land, the question arises of whether or not a separate basisshould be established for the proportion of the original basis due to this right. This may be determined by whether or not under the provisions of the contract for the purchase of the forest land the carbon credit right separable from the timber, or runs with the timber.
[1]For an overview of carbon sequestration programs see http://www.extension.purdue.edu/extmedia/FNR/FNR-228-W.pdf, one of many excellent web-based publications and websites.
[2]The Natural Resources Conservation Service (NRCS) is the most common source of payments for watershed protection. New York City Dept. of Environmental Protection has a comprehensive program for private lands in the watershed, see http://www.nyc.gov/html/dep/html/watershed_protection/resources.shtml
[3] Code §1402(a)(1)
[4]Somewhat different standards apply to taxpayers and tax preparers. See §6694(a)(2) and §6694(a)(3) as amended by P.L. 110-28. Also note that changes to these standards are included in legislation under consideration in the 111th Congress.
[5]The term “easement” is generally used to describe the granting of a limited right a person to use the real property of another person. A positive right is established. A conservation easement, however, establishes a negative right in one person in the real property of another person, creating a “negative servitude.”
[6]Most states have adopted in whole or in part the provisions of the Uniform Conservation Easement Act, first adopted by National Conference on Uniform State Laws in 1981.
[7]This is the case regardless of how such a contract is treated under the Internal Revenue Code.
[8]The California Air Resources Board has promulgated a requirement that a conservation easement be in effect on any forest land used for carbon emission offsets under CARB’s cap-and-trade program.
[9]A frequently referenced example is the Van Eck Forest Project in California, see http://www.itsgoodtobegreen.com/pdfs/QandA.pdfand http://www.pacificforest.org/stewardship/vaneck/index.html .
[10]If a contract does not transfer the interest(s) in perpetuity a leasehold interest has been established, a disposal has not taken place.
[11]This is the sum each year’s expected rent less costs discounted back to the appraisal date at an assumed interest rate.
[12]In Garbiniv. Commissioner, TC Summary Opinion 2004-7 (1/23/2004), [summary and court report in Appendix C] the taxpayer argued that for purposes of the hobby loss rule, Code 183, the court should include in its assessment of profit potential value of carbon rights should.
[13]There are significant economies of scale for carbon sequestration contracts, making a contracted acreage this small unusual.
[14]Reg. §183-1
[15]Sec. 194, discussed in Chapter 4.
[16]Sec. 194(c)(1) defining Qualified Timber Property
[17]Our assumption is that unless the price of carbon credits increases substantially the rent from these contracts will not be sufficient by itself to justify the profit potential of a “tree farm.” Thus, focusing on the timber value remains important.
[18]See for example, Wilmington Trust Co. et al v. U.S., 221 CtCls 680, 610 F2d 703, 43 AFTR 2d 79-801, 79-2 USTC 9707 (2/23/1979).
[19]The volume of timber existing when the conservation easement was executed was disposed of in the sense that this volume must always be maintained on the land. This volume can’t be sold for economic gain. Put another way, the equitable interest in the severance right has been disposed of. Any interests not requiring severance and not otherwise disposed of are retained by the forest owner.
[20]Olmsted discusses from the standpoint of the owner (grantee) of a conservation easement possible contract provisions for carbon offsets. (Olmsted, James L. 2009. Perpetuity, latent ancillary rights, and carbon offsets in global warming era conservation easements. Environmental Law Reporter 39:10842-10850.
[21]The land basis maintained in the land account must be allocated between the development rights disposed of and the value of the land with the remaining rights. The many appraisal issues associated with carbon sequestration valuation are not discussed here.
[22]Because timber is an above-ground, renewable, and measurable natural resource it is not necessary to keep tract of individual trees, or specific stands of timber, in order for the terms of a contract such as this to be enforceable.
[23]See Williston on Sales, 5th Ed.
[24]It may seem counter intuitive that a given volume of timber can be disposed of in terms of its severance, and also leased in terms of carbon sequestration and as growing stock for the addition of additional volume. The validity of such contracts most likely will depend on the willingness of courts to accept the forest measurement (forest mensuration) reports of professional foresters specializing in this service. Given the long history of this practice and its use in a long string of timber valuation cases under IRC Sec. 631(a) there is no reason to reject this possibility.
[25]Rev. Rul. 62-81, 1962-1 C.B. 153
[26]Although it is possible in most states to establish an estate in timber separate from the estate in the underlying land, this is unusual. In addition, the holder of the timber estate would need rights in the land sufficient to take economic advantage of the timber. Thus, any such separation would need to have characteristics of a long-term lease.
[27]Since under IRC Sec. 611-1(b)(1) it is no longer necessary to retain an economic interest by tying the amount paid to the volume actually severed, it is not necessary for Stewart to tract the volume cut and base the rent on the cut volume times the contracted price per unit volume. Capital gains treatment is not determined by the payment schedule for the timber harvested. If Stewart has not severed the volume of timber present on the date of the contract, then an adjustment in the amount of payments qualifying for capital gains treatment would have to be made by the lessors.
[28]Latterra v. Commissioner, 437 F.3d 399, 4/5/2006, (3rd Cir. Court of Appeals)
[29]Rev. Rul. 57-9, 1957-1 C.B. 265. Cutover timberland was purchased by an investor. He sold rights to pull the stumps. Capital gains treatment was allowed under Code §1221 because he was not in the business of buying and selling timber.