Economics of Tree Farming

Economics of Tree FarmingClint Bentz, CPA, CMA, MWMBoldt, Carlisle & Smith, LLC(541) 928-6500cbentz@bcsllc.com

OverviewWhat is Return on Investment?Financial and non-financial returnsAccounting for your woodlandIncome & Estate tax issuesProperty tax programsPutting it all together to compute financial ROIYour familys ROIWhat is Return on Investment?Payback period: No. of years to return your moneyNet Present Value: How much you will earn in todays dollars over your target earnings rateInternal Rate of Return: Your earnings (interest) rate over the life of the investmentPre-or post tax calculationEffect of inflationCreating a model allows you to determine if certain investments pay offFinancial & Non-financial ROITop 10 reasons for owning family forests (2008 USFS survey):Enjoy beauty or sceneryFamily heritagePrivacyNature protectionConnected to home or cabinInvestment (6)Hunting or fishingPart of farm or ranchHiking, snowmobiling, and other recreationTimber production (10)

What is Highest & Best Use?Timber production?Recreation?Retreat?Development?Begin with the end in mind! (Steven Covey)An Intergenerational AffairPlantingHarvest1st Generation2nd Generation3rd Generation4th Generation5th GenerationEstate Planning That Puts Your Family FirstApril 7, 2001(c) 2001 Clint Bentz, CPA - cbentz@bcsllc.com 503-769-21866One Plants, another Tends, a third ReapsWe dont live long enough to profit from our own work!

Just of few of the Common Problems making this work:

Money thanks, but Id rather have cash Cash flow to operateAddictions we have family members who have personal problems that need to be planned forEstate Taxes need to plan for it, rules constantly changingLack of skills your kids may have grown up on tree farm, but dont know anything about the business of running the tree farmControl issues need to groom a successor share decision making. Birth order issues.Relationships Last time most kids spent together was in middle and high school brain damage.

Your children need to be more than members of your family they need to become business partners.

1909 FORD Model T

The Year 1909Average Life Expectancy: 47 years14% of homes had a bathtub8% of homes had a telephoneModel T invented factory open in 1910Only 8,000 cars and 144 miles of paved roads in the US.Tallest structure: Eiffel Tower @ 990Average wage: 22 cents/hourAverage annual wage: $200-$400/yrNo income tax, gas tax, or sales taxOver 95% of births were at home90% of doctors had no college degreeWomen washed hair once/monthFive leading causes of death (in order):Pneumonia & influenzaTuberculosisDiarrheaHeart DiseaseStrokeAmerican flag had 45 stars230 reported murders in the USAPopulation of Las Vegas, NV: 306% of Americans graduated from HS20% of Americans illiterateNo crossword puzzles, canned beer or ice tea (not invented yet)No Mothers or Fathers DayCutting edge technology: Steam!

1910 Census Percentage of Rural Households by State Natl 53.85%The Year 1910 vs. 2010US Population: 92million vs. 310m % living in rural: 54% vs. 16%Number in rural: 50m vs. 50m2.5m farms, 10m woodland, 37.5m other2012 Pew Research Study53% of 18-24 year olds living with parents29% of 25-34 year olds living with parentsHighest % of multi-gen households since 1950sWhat will the world be like in 2110?NEED TO STAY FLEXIBLEPass on values and passion!Accounting for your WoodlandCost Basis of Land, Timber & ImprovementsOriginal purchase price allocated pro-rataAdditional capital improvements and acquisitionsAccumulated depletion & depreciationAnnual income and expensesCheck registerDouble entry accounting (debits = credits)Tax accounting and budgeting/planning purposesTimber growth and yield

Income Tax IssuesDepletionComputing taxes on sale of timberPassive Loss rulesReforestationHarvest & Privilege TaxDepletionRecovery of cost basis in timberPro rata over all components of valueExample of Allocation ($350,000 purchase price):

Assets AcquiredIndividual ValuePercent of TotalAllocated BasisLand20,0005%17,500Timber200,00050%175,000Residence140,00035%122,500Barn20,0005%17,500Reproduction20,0005%17,500Total400,000100%350,000DepletionComputed over all timber now standingDeduction computation example:Original basis allocated to timber $175,000Timber standing before harvest 300 MBFTimber harvested during year 200 MBF or 67%Depletion deduction = $175,000 x 67% = $117,250Remaining basis = $200,000 - $117,250 = $57,750631(a) ElectionTIMBER OWNERStumpage value at Jan 1 of harvested timberLess depletion deductionNet is Section 1231 capital gain from sale of business propertyLOG SELLERGross receipts lessStumpage (COGS)Less operating costsNet is Ordinary income (loss)631(a) Election1231 Gain reported on 4797 transferred to Schedule DOrdinary income on Schedule CRecognize 631(a) gain in year timber is severed and measured.Must make election (Form T) on timely filed returnElection is irrevocable.631(a) Computation$200,000 gross proceeds from mill$150,000 631(a) Value (determined by appraisal)$117,500 depletion deduction$70,000 logging, hauling & operating costsTaxable income = $200,000 - $117,500 - $70,000 = $12,500Schedule CForm 4797Gross Sales200,000Sec 631(a) Cost/Gain(150,000)$150,000Depletion (cost basis)(117,500)Logging & operating costs(70,000)Taxable Income(20,000)32,500Passive Loss Rules (1986 Tax Act)60-100 years of losses, 1-5 years of income in business cycle.Safe Harbor: Income three years out of five.Three types of income:Active (wages, material participation business)Portfolio (interest, dividends, capital gains)Passive (rents, passive business)Losses from passive activities dont offset other incomeMaterial participation is based on hours spent in the activity. Burden of proof is on the taxpayer. Assertion on tax return.

7 Material Participation Rules1. 500 hour rule.2. Less than 100 hour rule.3. Between 100 and 500 hour rule.4.Multiple businesses rule (between 100-500 hrs).5.Five of last 10 years rule.6.Facts and circumstances rule.7.Personal service activity N/A.Material Participation RulesTaxpayer and spouse time counts twiceInterplay with 100-500 hour testSurviving spouse needs to meet active management test if farmRetired or disabled OK if material participant for 5 of 8 years preceding retirement/disability if farmDont have to meet same test each yearBased on facts and circumstances be careful!Need to keep a record of your hours!ReforestationReforestation costs are capital costs, not available for depletion until first commercial entryCovers all costs to establish a forest (see Forest Practices Act for definition)Can elect to deduct up to $10,000 per year per Qualified Timber Property (on Form T)Can elect to amortize (Sec 194) amounts over $10,000 per calendar year for 7 yrs (with half year convention).ReforestationCost share payments included in incomeACP, FIP, ACP, EQIP pmts can be offset against costs based on formulaState tax credit of 50% for conversion of underproductive lands. Program sunsets 12/31/2011.Discuss proposed project with stewardship forester firstSite prep & planting done in 2011Limited to commercial forestland not meeting minimum stocking requirements under FPAHarvest TaxHarvest tax levied on timber harvested on all land in Oregon.Due by January 31. Pay by 12/31 to deduct.If expect to owe $1,500 or more, must pay estimates.First 25 MBF harvested annually exemptConvert tons to MBFLoads where