If you have been in the business of buying private timber stumpage for awhile, you have probably met landowners that do not want to sell their trees at any price. They may even have over-matured aspen that is dying, but you still can't convince them to let you cut it and start a new crop.

They may give you various reasons why they will not sell. Some of them valid; others not. Don't just go away shaking your head in confusion, help them out.

I have found that, in most cases, the landowner is afraid of the income tax consequences! They have probably talked to other landowners that sold timber and heard horror stories about paying more than half of their stumpage income for federal and state taxes plus being forced to pay the Social Security tax of 15.3%. Or else they talked to their tax accountant, who told them not to sell because it would put them in a higher tax bracket and cause them to pay much higher taxes.

These are not valid reasons for refusing to sell. If you have read any of my articles in the past, you know that the landowner should report the timber income as long-term capital gain and only pay between 5% - 15% in federal tax and the self-employment tax of 15.3% does not apply. They are also able to take a depletion deduction which further reduces their tax liability.

The income tax law that apply to sales of timber is a specialized area of the tax code. A large percentage of tax preparers have little or no knowledge of these laws. Even if some of them do, they have no idea of how to implement them without professional training as a forester.

The result of this lack of knowledge is that most landowners end up having their sale reported as ordinary income which means they paid hundreds or, in many cases, thousands of dollars more than they needed to.

One, real life example, that could apply to you loggers in the business of buying private timber vividly illustrates what can happen. A client I helped out, let's call him Bob, owns 40-acres of high quality red oak sawtimber. Upon reaching age 62, Bob retired and started drawing Social Security income. He was then approached by a log buyer for a sawmill about selling some of his sawtimber. He was impressed with the high value of the offer and how the money would help in his retirement years, so he entered into a timber sale contract with the sawmill company.

The logging job was done well and he was paid all of the stumpage due him. Bob was happy until he took this transaction into his tax accountant. His accountant told him that he never should have sold the timber because it placed him in the highest tax bracket. Federal and state taxes plus the self-employment tax were going to eat up most of his revenue plus lose his Social Security income.

As you can imagine, Bob was no longer happy. His very next stop was at his lawyer's office, which resulted in a law suit being filed against the log buyer and the sawmill for not explaining these tax consequences!

There is a happy ending, however. While getting information together for the law suit, Bob talked to the forestry extension agent at the university, who informed him that his tax accountant was wrong and he should talk to me.

By reporting his income correctly, I saved Bob over $18,000.00 in federal tax plus he got to keep his Social Security income. The law suit was dropped and Bob was happy again.

Large tax savings or refunds make for happy landowners and that's what you want for your business. An easy and inexpensive way to do this is simply to tell them about the timber tax law. You don't have to be an expert, just make a copy of this article and let them read it. Also, tell them that if their tax preparer says this is not legal, or they can't use it for any reason, they can contact me for a second opinion at no charge.

You joined this association because you care about your timberland and want to manage it using sound forestry practices. If you have merchantable timber, you probably hired a forester, wrote a forest management plan, carefully designated your trees for a timber sale, then actually received payment for the trees harvested.

All of the forestry advice has paid off; you finally made some money. Everything (you think) is going according to plan, until you report your timber income for taxes, then find out you’re going to pay a huge sum of money in federal and state income taxes. Depending on the tax bracket plus the self-employment tax, some taxpayers end up paying more than half of their sale proceeds to the government!

Suddenly, all of this forest management doesn’t look like a good deal. If this scenario sounds familiar don’t feel bad; you have a lot of company.

Capital gain tax treatment of timber sale income is detailed primarily under Sections 631(a) and 631(b) of the Internal Revenue Code. This is a highly specialized area of the tax law. The terminology used and appraisal requirements that are specified are written for experienced foresters. Most accountants do not have this kind of background, nor are they confronted with timber sales on a regular basis, if at all.

Based upon my experience, I would say that at least a majority of tax accountants know nothing about the sale of trees (timber) being capital gain income. The ones that do have no idea how to calculate a depletion deduction or implement the other provisions of Sections 631(a) or (b). The result of this is that most timber sales are reported as ordinary income, which when added to other income can move the taxpayer into a higher tax rate bracket plus, require the payment of an additional 15.3% for the self-employment tax, resulting in the huge tax bill referred to in my opening scenario.

In order to get the lowest tax rates possible, income from the sale of timber should be reported on your federal and state income tax returns as capital gain. If you owned the timberland for one-year or longer, your income qualifies as long-term capital gain and will only be taxed at a minimum of 5% to a maximum of 15% rate. The self-employment (Social Security) tax of 15.3% or the Alternative Minimum Tax does not apply.

If you sold timber in less than the one-year holding period, you should still report the income as short-term capital gain. The Net income will be subject to ordinary tax rates, but you still get to take a depletion deduction.

Whether you have long or short-term gain, you start with the gross income received then deduct any expenses associated with making the sale, such as payments to a forester for services, your travel expenses to inspect the land, etc. In addition to these expenses, you are entitled to take a timber depletion deduction for the volume of timber cut and sold.

The depletion deduction is a tax free return of your cost basis in the trees growing on the land at the date you acquired the property. How this deduction is arrived at would require a separate article to explain, but suffice it to say, it is an important part of minimizing the tax that you will have to pay. For example, clients of mine that purchased their property within the last 5 to 7 years usually end-up with a loss for tax purposes because their depletion deduction is greater than the amount they received for the trees that were cut and sold. In other words, they paid no tax, plus had a loss to deduct from other income.

Normally, the tax savings between reporting as capital gain versus ordinary income is large – thousands of dollars.

I learned about capital gain tax treatment of timber when I was a forestry student and recognized what a great tax benefit it was to practicing good forest management. It puts forestry on a par with investing in the stock market.

Most foresters learned about this in school as well, but by inclination, want to concentrate on managing forests and leave taxes to the accountants. Accountants, on the other hand, probably never heard anything about timber in school. Hence, there is a big information disconnect between the two professions, which took me years to realize.

I owned and operated a forestry consulting firm for 25-years and as a standard business practice always prepared the Form T required to substantiate the depletion deduction and capital gain for each of my timber sale clients. Without exception, the tax preparer for every client would call to ask if this was legal and the correct way to report the income! I didn’t matter if it was a high-powered tax firm in Boston or a local accountant.

For the past seven years I have been writing articles such as this and specializing in completing the tax reports for anyone’s timber sale. Every year I receive a disturbing number of calls from readers who tell me that their tax preparer informed them it was not legal, or it could only be used by big corporations, or farmers could not use it, or various other reasons too numerous to mention. Based upon this experience, I have to conclude that this is a common occurrence throughout the country, not just the mid-west.

Anyway, don’t give up on forest management – it pays off. Just remember to include capital gain taxation in your forest management plan for future timber sales. If you sold timber within the last three years and reported the sale incorrectly, all is not lost, file an amended return.

In any event, if your tax preparer says you can’t use the capital gain provisions, have them call me for a second opinion.