Capital Expenditure RecoveryCapital Expenditure Recovery

Chapter 3Chapter 3

Land AccountLand Account

• Land account – assets include the land and non-Land account – assets include the land and non-depreciable improvementsdepreciable improvements

• Basis in recovered only when land is sold or Basis in recovered only when land is sold or otherwise disposed of otherwise disposed of

• Cost of protecting title and combating adverse Cost of protecting title and combating adverse possession is capitalized into the land accountpossession is capitalized into the land account– See Anderson Tully See Anderson Tully – And Wacker casesAnd Wacker cases

DepreciationDepreciation

• General rule – annual deductions may be taken forGeneral rule – annual deductions may be taken for– ““Property” used in a business orProperty” used in a business or– Held for production of income (i.e., an investment)Held for production of income (i.e., an investment)

• Property must have a limited and determinable Property must have a limited and determinable useful lifeuseful life

• It must either wear out, decay, get used up, It must either wear out, decay, get used up, become obsolete or lose value from natural causes become obsolete or lose value from natural causes [IRC [IRC §167(a)]§167(a)]

Timber Related Real PropertyTimber Related Real Property

• IRC IRC § 611 authorizes depreciation deductions § 611 authorizes depreciation deductions for timber related improvementsfor timber related improvements

• Generally, depreciation methods applicable to Generally, depreciation methods applicable to all taxpayers apply to timber-related real all taxpayers apply to timber-related real property improvements – IRC § 168property improvements – IRC § 168

• E.g., temporary roads, bridges, fences and E.g., temporary roads, bridges, fences and culverts may be depreciated over a MACRS 15-culverts may be depreciated over a MACRS 15-year recovery periodyear recovery period

Section 179 DeductionSection 179 Deduction

• 2002 -- $25,000 of qualifying property may be 2002 -- $25,000 of qualifying property may be deducted if associated with an “active business”deducted if associated with an “active business”

• Estates and trusts are not eligible.Estates and trusts are not eligible.• 2003 -- Tax Act temporarily raised limit to 2003 -- Tax Act temporarily raised limit to

$100,000 for property placed in service in $100,000 for property placed in service in taxable years beginning in 2003 – 2005taxable years beginning in 2003 – 2005

• 2008 -- Econ. Stim. Act -- deduction $250,000 2008 -- Econ. Stim. Act -- deduction $250,000 • 2010-11 – Limit increased to $500,000 by the 2010-11 – Limit increased to $500,000 by the

Small Business Jobs Act of 2010Small Business Jobs Act of 2010

Timber DepletionTimber Depletion

• Generally, taxpayers can recover their Generally, taxpayers can recover their investment in property tax-free when soldinvestment in property tax-free when sold

• The gross sale proceeds are reduced by the basis The gross sale proceeds are reduced by the basis in the property soldin the property sold

• Same principle applies to timber – if all timber is Same principle applies to timber – if all timber is sold, entire basis is recoveredsold, entire basis is recovered

• If only part of timber is sold, basis is If only part of timber is sold, basis is “equitably “equitably apportioned”apportioned” to part sold (Part II of Form T) to part sold (Part II of Form T)

Depletion RulesDepletion Rules

• Most timber dispositions involve non-fungible Most timber dispositions involve non-fungible trees – e.g., mature trees are cut and less mature trees – e.g., mature trees are cut and less mature growth is retainedgrowth is retained

• IRC has special “depletion” rules that allocate IRC has special “depletion” rules that allocate the trees cut and those that remainthe trees cut and those that remain

• Depletion is used in two waysDepletion is used in two ways– ““Allowable as basis of sale” and Allowable as basis of sale” and – Depletion deemed to be the “basis allocable” to the Depletion deemed to be the “basis allocable” to the

timber cut – IRC timber cut – IRC § 631§ 631

Recovery of Timber BasisRecovery of Timber Basis

• Taxpayer needs to know: Taxpayer needs to know: – Adjusted basisAdjusted basis in timber account – original basis in timber account – original basis

plus purchases, transfers and capitalized cost; and plus purchases, transfers and capitalized cost; and less sales, gifts and involuntary conversionsless sales, gifts and involuntary conversions

– Total volumeTotal volume in timber account – original volume in timber account – original volume plus growth, purchases, and transfers; less sales gifts plus growth, purchases, and transfers; less sales gifts and involuntary conversionsand involuntary conversions

• See Part II of Form TSee Part II of Form T

Depletion CalculationDepletion Calculation

• The The depletion unitdepletion unit equals equals – Adjusted basis divided by the total volumeAdjusted basis divided by the total volume– It is the $ investment per unit of measureIt is the $ investment per unit of measure

• DDeductible basiseductible basis for timber sold or disposed of for timber sold or disposed of– The depletion unit times the number of units cut, The depletion unit times the number of units cut,

sold, or otherwise disposed of sold, or otherwise disposed of

• Results are identical whether a lump sum sale or Results are identical whether a lump sum sale or a disposal under IRC a disposal under IRC § 631(b) are used§ 631(b) are used

Amortization ElectionAmortization Election

• Complete Depreciation and Amortization Form Complete Depreciation and Amortization Form 4562, part VI and attach to return4562, part VI and attach to return

• Attach Form T, Part IV, or similar information Attach Form T, Part IV, or similar information on a plain sheet of paperon a plain sheet of paper

• Election must be made on a timely filed, but Election must be made on a timely filed, but cannot be made on an amended returncannot be made on an amended return

• Investors take deduction on front page of Form Investors take deduction on front page of Form 1040, businesses on Schedule C or F1040, businesses on Schedule C or F

New Expensing and Amortization New Expensing and Amortization Procedures After 10/22/04Procedures After 10/22/04

• Qualified reforestation expenditures up to $10,000 per Qualified reforestation expenditures up to $10,000 per year may be expensed for each “eligible timber year may be expensed for each “eligible timber property,” defined as one having a unique “stand property,” defined as one having a unique “stand identifier” -- IRS has been unresponsive with additional identifier” -- IRS has been unresponsive with additional information!information! Note that all managed forests with a Tree Farm Name, Location, Management Units and a stand level designation have “a unique stand identifier”

• Amounts exceeding $10,000 may be amortized Amounts exceeding $10,000 may be amortized • Expense deductions are subject to the passive activity Expense deductions are subject to the passive activity

loss rules – business must be activeloss rules – business must be active

Investment Tax Credit was repealed Investment Tax Credit was repealed on October 22, 2004on October 22, 2004

Revenue Ruling 2004-62 Revises Revenue Ruling 2004-62 Revises Treatment Of FertilizerTreatment Of Fertilizer

• IRS’s withdrawal of GCM 39371 signaled a lack IRS’s withdrawal of GCM 39371 signaled a lack of agreement on fertilizer, and with no published of agreement on fertilizer, and with no published authority, policy was left to district supervisorsauthority, policy was left to district supervisors

• Generally, it was capitalized when reforesting, Generally, it was capitalized when reforesting, but, expensing in established stands was based but, expensing in established stands was based on the useful life of fertilizer on the useful life of fertilizer

• Following Rev. Ruling 2004-62, taxpayers may Following Rev. Ruling 2004-62, taxpayers may expense fertilization in established standsexpense fertilization in established stands