What Is Basis
Basis is the amount of your invested money or cost of your property such as timber or land. Basis is not the current value of your property. To determine net taxable income, basis is subtracted from gross sale income. This subtraction is called basis recovery and can reduce taxes significantly. Basis recovery usually occurs when property is sold. But basis can also be recovered when property is lost in a casualty, as in a fire or storm. Land and timber are properties that can be bought and sold separately. Therefore, it will be to your advantage to set up different accounts for land and timber and keep separate record of basis. Internal Revenue Service (IRS) regulations also require landowners to keep separate land and timber accounts. Inflation reduces the value of basis every year. To minimize this financial loss, you need to be aggressive in using basis recovery.
How Is Basis Established?
The way you acquire property typically determines how the initial basis is established. The acquisition method determines your first entry for basis in the land account or the timber account. You can become a property owner one of four ways:
- You purchase property.
- You inherit property.
- You receive property as a gift.
- You plant trees on land you own or lease.
What Is the Initial Basis for Purchased Property?
When you buy timberland, the initial value of basis is equal to the purchase price. Include with the purchase price any legal, surveying, and consulting fees paid. Allocating of purchase price into land basis and timber basis is guided by the percentage of fair market value (%FMV) attributed to land and timber (Example 1).
Example 1. Allocating Basis between Land and Timber for Purchased Timberland.
Twenty acres of timberland were purchased for $20,000. It was a good deal -- an appraisal showed fair market value (FMV) for timber was $30,000 and land was $10,000. A few simple calculations show that the timber made up ¾ of the total value and the land accounted for ¼. Multiplying the percent value by the amount actually paid will equal your original basis for each part respectively.
Calculations:| %FMV | = | (FMV/TOTAL) × 100% |
| Land %FMV | = | ($10,000/$40,000) × 100% = 25% |
| Timber %FMV | = | ($30,000/$40,000) × 100% = 75% |
| Basis | = | (%FMV) × Purchase Price |
| Land Basis | = | 25% × $20,000 = $ 5,000 |
| Timber Basis | = | 75% × $20,000 = $15,000 |
| Account | FMV | %FMV | Basis |
| Land | $ 10,000 | 25% | $ 5,000 |
| Timber | 30,000 | 75% | 15,000 |
| TOTAL | $ 40,000 | $ 20,000 | |
Therefore your basis in the property is $20,000.
What Is the Initial Basis for Inherited Property?
Initial value of basis for inherited property is equal to the fair market value (FMV) at the time of your donor's death. If estate distribution is delayed, you may use instead the FMV on the date of your acquisition.
Most inherited land and timber property subject to estate taxes will receive a step-up basis equal to FMV. But this may not be the case for a surviving spouse of jointly owned timberland. In some states only half of the property is assumed to be inherited, so only half of the FMV is initial basis.
An appraisal is needed to establish the FMV of your land and timber. The most accurate appraisal occurs when you acquire the property.
Sometimes an appraisal is not made until the property is sold. In this case, a retroactive appraisal to establish basis is allowed by the IRS if it is done by a consulting forester. The FMV for the date when you inherited the property is estimated by projecting backwards the timber and land values (Example 2). Any fees charged for a retroactive appraisal can be allocated to land and timber accounts using %FMV as a guide.
Example 2. Retroactive Basis Determination for Inherited Land and Timber.
Fifty acres of timberland were inherited 10 years ago. This year, a forestry consultant was paid $300 for the following information: current timber volume was 500,000 board feet (500 MBF), timber growth in past averaged 200 board feet (b.f.) per acre per year, and timber prices 10 years ago were $150/MBF. Comparable bare land 10 years ago was valued at $250/acre.
Calculations:| Initial FMV Land | = | $250/acre × 50 acres = $12,500 |
| Initial Volume | = | Present Volume - Growth |
| = | 500,000 b.f. - (200 b.f. × 50 acres × 10 years) | |
| = | 400,000 b.f. | |
| = | 400 MBF | |
| Initial FMV Timber | = | $150/MBF × 400 MBF = $60,000 |
| Total FMV Property | = | $12,500 + $60,000 = $72,500 |
| Allocation of Consulting Fee | = | (FMV/FMV Total) × Fee |
| Land Allocation | = | ($12,500/$72,500) × $300 = $51.72 |
| Timber Allocation | = | ($60,000/$72,500) × $300 = $248.28 |
| Basis - $ | |||
| Account | InitialFMV | AppraisalFee | Total |
| Land | $12,500 | $ 51.72 | $12,551.72 |
| Timber | 60,000 | 248.28 | 60,248.28 |
| TOTAL | $72,500 | $300.00 | $72,800.00 |
Therefore your basis in the property is $72,8000.
What Is the Initial Basis for Property Received as a Gift?
Timberland given to heirs before death avoids estate taxes. Because of estate avoidance, your initial entry in basis will be the same as your donor's basis in the property. To establish your donor's basis, you need to know how and when your donor acquired the property. If no records were kept, you may have to accept a basis of zero.
What Is the Initial Basis for Planted Trees?
If you establish your own trees, the initial value of basis is equal to reforestation costs and includes tree planting or seeding and site-preparation costs. There are some options when using reforestation costs. One option is to keep reforestation basis in the timber account until the timber is sold. Another option, which is usually better, is the use of investment tax credit (ITC) and amortization. Reforestation costs of up to $10,000 each year can qualify. Investment tax credit (ITC) allows a 10 percent tax credit for reforestation costs (Example 3). Credit is taken the same year costs are paid, using IRS Form 3468. Amortization of reforestation costs follows ITC. If ITC is taken, then 95 percent of expenses can be recovered using amortization. This 7-year recovery schedule starts in July, so amortization of costs takes 8 tax years. Recovery of costs is recorded on IRS Form 4562.
Example 3. Investment Tax Credit (ITC) and Amortization.
Reforestation costs in year one were $10,000.
| ITC = Reforestation Costs × 10% | = | $10,000 × 10% |
| = | $1,000 Tax Credit | |
| Basis = Reforestation Costs × 95% | = | $10,000 × 95% |
| = | 9,500 |
| Amortization Schedule | ||
|---|---|---|
| Year | Amortized Fraction | Amortized Amount |
| 1 | 1/14 | $ 678.58 |
| 2 | 1/7 | 1,357.14 |
| 3 | 1/7 | 1,357.14 |
| 4 | 1/7 | 1,357.14 |
| 5 | 1/7 | 1,357.14 |
| 6 | 1/7 | 1,357.14 |
| 7 | 1/7 | 1,357.14 |
| 8 | 1/14 | 678.58 |
| TOTAL | $9,500.00 | |
What Records Are Needed in a Land Account?
A land account summarizes your land ownership. Records are kept on land acreage owned and basis or costs associated with land (Example 4). Expenses to improve land such as permanent roads, fire lanes, and dams are added to the initial value of land basis. An average cost per acre is then calculated: Average Cost = Basis / Acres Your first recovery of basis will occur with a land sale:
Basis Recovery = Acres Sold × Average Cost
Any recovery of basis on taxes reduces basis in the land account a similar amount.
Example 4. Land Account Record Keeping.
Forty acres of land were purchased for $10,000. Legal fees allocated to land were $250, and a permanent road cost $1,000. When 5 acres were sold, basis was recovered.
Basis Recovery = 5 acres × $281.25/acre = $1,406
| Transaction | Acres | Basis | AverageCost($/Acre) |
|---|---|---|---|
| Purchase | 40 | $ 10,000 | $ 250.00 |
| Acquisition Fees | + 250 | ||
| Road Building | +1,000 | ||
| SUBTOTAL | 40 | 11,250 | 281.25 |
| Land Sale | -5 | ||
| Basis Recovery | -1,406 | ||
| TOTAL | 35 | $ 9,844 | $ 281.25 |
Tax options are available for costs of land improvements that deteriorate over time. These temporary improvements include bridges, culverts, and gravel. Temporary improvement costs can be placed in the land account, depreciated over 15 years, or recovered in 1 year with a Section 179 deduction. See IRS Publication 946 (Depreciating Property) for more information on these tax options.
What Records Are Needed in a Timber Account?
A timber account monitors two items: timber basis and inventory of timber volume. Records are usually updated about every 5 years to keep up with volume growth. If your land ownership is less than 500 acres, it is recommended you use an averaging timber account. This simplifies record keeping. Different product and species volumes are converted to cords and combined into one inventory volume (Example 5).
How Are Records Kept on Timber Basis?
The IRS wants you to use depletion to deduct basis. The formula used is as follows: Depletion = Basis / Inventory. Initial depletion for the averaging account in Example 5 is $20/cord. In this example, you could recover $20 for every cord of timber sold, lost, or stolen. Following 5 years of timber growth, depletion decreased to $15/cord.
Example 5. An Averaging Timber Account.
You purchased 150 MBF sawtimber and 300 cords of pulpwood for $15,000. Timber grew 250 cords in a 5-year period.
| Sawtimber Volume | = | 150 MBF × 3 cords/MBF = 450 cords |
|---|---|---|
| Inventory | = | Sawtimber + Pulpwood Volumes |
| = | 450 + 300 = 750 cords | |
| Depletion | = | Basis/Inventory |
| = | $15,000/750 cords = $20/cord |
| Averaging Timber Account | |||
|---|---|---|---|
| Time | Basis | Inventory | Depletion |
| Cords | $/cord | ||
| Initial | $15,000 | 750 | $20 |
| 5-year growth | +250 | ||
| Current | $15,000 | 1,000 | $15 |
How Is Depletion Used To Recover Basis?
Following a timber sale, basis recovery depends on depletion and the volume of timber sold (Example 6).
The formula is as follows:
Basis Recovery = Depletion × Volume
Example 6. Using Depletion To Recover Basis.
A thinning yielded 300 cords of pulpwood, selling for $6,000. Depletion is $15/cord.
| Sale Income | $ 6,000 |
| Recovered Basis | - 4,500 |
| Net Taxable Income | $ 1,500 |
| Recovered Basis | = | Depletion × Volume |
| = | $15/cord × 300 cords = $4,500 |
You will reduce basis as you recover costs for timber sold, lost, or stolen. Once a final harvest is made and all timber is cut, the basis should be reduced to zero.
How Can Timber Basis Be Increased?
Basis can increase only by adding expenses into the timber account--not by deducting them. Your timber basis will not change as trees grow in size or value nor will it change with inflation.
You can add part of the fees to do a title search, survey, and appraisal. In Example 2, 25 percent of appraisal fees were allocated to land basis. The remainder was allocated to timber basis.
You can add to basis your property taxes, mortgage interest, and costs of overseeing and protecting timber. Adding these costs to basis one year will not jeopardize deducting these costs from income the following year.
You should not add to basis other management costs such as precommercial thinning, herbicides, and fertilization. Once you add these costs to basis, your ability to deduct them as an annual expense vanishes.
If you purchase or inherit premerchantable trees, you can add their basis to the timber account once pulpwood volume is measurable. For pine plantations, this occurs at age 9-15 years. Add the cords of pulpwood to inventory and the premerchantable basis to timber basis.
How Can a Timber Account Be Updated Following a Sale?
Basis and inventory need to be current before a sale occurs. Following the sale, subtract the volume removed from inventory. Also subtract the basis recovered on taxes. Example 7 shows how to record these changes. Losses in timber from casualties, such as storms and fires, are handled the same way.
Example 7. Updating a Timber Account.
Following the timber sale in Example 6, recalculate basis and inventory.
| Time | Basis ($) | Inventory (cords) |
|---|---|---|
| Before Sale | $15,000 | 1,000 |
| Volume Sold | -300 | |
| Basis Recovered | -4,500 | |
| Current | $10,500 | 700 |
Which Income Tax Forms Should Be Filed?
You usually use Schedule D Form 1040 (Example 8) for income reporting and basis recovery from timber sales. Net income reported there is taxed as a long-term capital gain. Reporting a casualty loss in timber and recovering basis require IRS Form 4684 (Casualties and Thefts).
Example 8. Reporting Timber Sale Income and Basis Recovery on Schedule D.
Use income and basis from Example 6.
