Managing your forest land – Landowners Top-10 Frequently Asked Questions
US Forest Service, State and Private Forestry – Northeastern Area
Forest Stewardship Program

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9.  What can I do on the finance and tax side to improve my profit potential?

Some forest owners want or need money from their forest, and some don’t. Those forest owners who want or need money from their property may still have nonfinancial interests in the property, such as recreation and privacy.  Those who do not plan to generate revenue would likely enjoy the financial advantages of forest ownership, but are not willing or able to satisfy the requirements.  The requirements to qualify for federal tax advantages as a forest owner, such as deductions for expenses, have stiffened in recent years to eliminate the tax shelters that some forest owners previously abused.  The answer to the question at hand has two parts, one related to property tax and the other related to taxes on income from the forest. 

How is the property tax on forest land determined?
The amount that forest owners pay in property tax varies widely among states and even within a state.  Commonly, property tax assessments on forest land are based on the highest and best use of that land, rather than the current use of that land.  Thus, a healthy and productive forest that provides innumerable and often immeasurable ecosystem services and requires little or no municipal investment as a recipient of services may be taxed at a rate associated with, for example, a housing development or a rural estate.  Unfortunately, the tax cost per acre often exceeds the potential for sustainable revenue.  Fortunately, most states have some type of forest property tax law that trades a lessened tax burden for some type of extra effort on the part of forest owners.  The extra effort is usually the development and implementation of a forest management plan.  In some states the forest owner also pays a yield tax at the time of a timber sale.  The advantages vary among states but ultimately result in a lessened tax burden.  The disadvantages also vary but take the form of extra stipulations through governmental controls.  Your state’s forestry agency will have additional information on forest property tax programs.

Is there a way to minimize the taxes I pay on income from my forest?
Your options for minimizing your liability for tax on forest-based income will depend on your ownership structure as business, investment, or hobby.  The structure of your forest ownership refers to how you define the relationship you have with your property for legal and tax purposes.  The way you classify your ownership will affect how you handle annual management expenses relative to your annual income, whether your income qualifies for capital gains treatment, and other considerations.  In some situations, your forest management expenses will be directly deductible from your nonforest personal income.  Several characteristics will help you and your financial advisor make the correct classification.  Characteristics to discuss include why you own the land, the activities you conduct on the land, whether you have or will sell timber, and how you handle your annual costs of ownership.  A business-minded approach to your forest will involve some additional tax forms, such as form T; but those are familiar to people who prepare taxes.

How can I take a business-minded approach to my forest?
The most favorable structure for reduced tax liability among forest owners is to be “active in the trade or business.”  This requires that you materially participate in the management of your forest.  Material participation can be defined in different ways, but it essentially means that you and your family members are the primary people involved in managing the land.  This tax structure affords specific advantages over investment and passive structures, such as a more favorable capital gains treatment, annual deduction of expenses, and the option to deduct up to $100,000 in one year for equipment purchases.

For forest owners who have a business-minded approach to the management of their property (note the IRS has definitions for this) may have the opportunity to deduct the costs of materials purchased for the generation of a profit from their forest.  An important distinction between other business activities and a forest as a business is that the forested property does not need to actually generate revenue each year, but only have the capacity to generate income.  Thus, if your trees grow, which they most likely will, your forest can qualify as a business. 

Forest owners wishing to take advantage of a reduced tax liability based on their business-minded approach to forest management should (1) visit with their financial advisor at the beginning of the tax year, (2) try to develop a basis for the value of their timber at the time the property was purchased by the current owner, and (3) begin a process of record keeping that will withstand scrutiny.  Financial advisors, some of whom are specially trained in forest-income tax issues, can help you decide what expenses are acceptable, what purchases need to be depreciated, and what expenses you carry until the property is sold.  Determining the basis is your way to document your initial investment and it is used to off-set the revenue generated through a timber sale.  Record keeping provides you the opportunity to document what you have done and why you have done it.  Your forest management plan becomes part of your records and should explicitly describe your intention for operating your forest as a business. 

Forest owners who take the business-minded approach may generate significant value in their forest land.  In some situations this creates barriers to the transfer of that land to heirs.  All forest owners should discuss the legacy of their land with their heirs and with an estate planner familiar with forest land issues.

Where can I find more information?

Topic	Recommended Web link
Forest-based tax issues	www.timbertax.org
IRS information, publications and forms	www.irs.gov http://www.timbertax.org/publications/irs/fip.asp
Federal taxes	http://na.fs.fed.us/stewardship/pubs/FITOT2005.pdf http://na.fs.fed.us/temp/TaxTips2005.pdf http://www.timbertax.org/publications/aghandbook/aghandbook.asp
Record keeping	http://pubs.cas.psu.edu/freepubs/pdfs/uh150.pdf http://msucares.com/pubs/publications/p2306.pdf http://www.utextension.utk.edu/publications/pbfiles/PB1691.pdf http://www.naturalresources.umd.edu/Publications.html#taxes
The structure of your forest for financial matters	http://www.timbertax.org/getstarted/structure/structure.asp
Forest property taxes	http://www.timbertax.org/statetaxes/property.asp Using a search engine, search for “forest tax law your state” for example “forest tax law Michigan”