Capital Gains and Timber Sales

Many woodland owners—and even their tax preparers—don’t realize they can treat timber sale income as capital gain.

Doing so can make a big difference in your profit, but it can take a few extra steps. That’s because the tax code section that allows timber to qualify for capital gains applies to standing timber only. If you were to cut your own timber or hire a logger to cut your timber, and then sell the logs, you would need to make a “special election” to treat your sale as a capital gain.

The “special election” means splitting the log sale into a two-part transaction: the sale of the standing timber that produces the logs, and the sale of the logs themselves.

The standing timber is treated as if it was “sold” to the landowner on the first day of the year of the cut, and the log sale is treated as a separate event.

Here’s an example to show you how it works: 

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Credit: Shuttershock

This year, you’ve decided to cut and sell 60 MBF from a tract you purchased in 2011 that has an adjusted basis  of $1,460.

The first step is determining the fair market value of the standing timber you plan to cut on the 1st of the year you plan to cut it – that is, January 1^st of this year. You determine this value was $7,500.

The gain for this part of the transaction is then equal to $7,500 (the fair market value on Jan. 1) minus the adjusted basis.

$7,500 - $1,460 = $6,040 is your gain, and this gain qualifies for capital gains treatment.

Now, let’s say you sell your logs later this year, and the sale proceeds are $9,600. The timber “sold” to yourself in the first part of this calculation has a value equal to the fair market value on January 1^st – $7,500. You also incurred some expenses in making the sale – for example, by hiring a logger to cut the trees – and those add up to $1,500.

So the gain for this part of the transaction is equal to $9,600 (the sale proceeds) minus $7,500 (the basis or fair market value for your timber on Jan. 1) and your sale expenses ($1,500).

$9,600 - $7,500 - $1,500 = $600 is your gain from the log sale alone.

The gain from this part of the transaction does not qualify for capital gains treatment. It gets treated as ordinary income.

Calculating your capital gains and understanding the tax rules around them can be confusing. If you’re not sure how to proceed, know that you’re not alone. A tax professional who’s familiar with the special tax issues woodland owners face can help you get a handle on your options and benefits.