Tree Farmer - September/October 2009 - (Page 26)

Carbon By hoover BILL Sequestration may be costs to maintain title to it, such as property taxes, and its physical condition may change naturally or because of improvements or wear-and-tear and depletion. While it’s held, it also might throw off income, such as rental or royalty payments for use of the asset. Any gain (loss) on the disposal of the asset is by definition capital in nature. That said, all income, whether earned or unearned, is ordinary income unless a specific provision of the Internal Revenue Code (IRC) qualifies it for capital gains treatment. I’ll return to this later. taxing issues 26 As promised in my last column (May/June 2009), here I discuss the contractual provisions that might provide capital gains treatment for payments received by Tree Farmers to sequester carbon. I hope you’ll forgive me for going technical on you. Rather than picking one type of contract and analyzing it in detail, I outline the tax principles involved in analyzing contracts. Maybe you’ll be fascinated by the legal nuances involved — or not. If not, please forgive me and pass this column on to your tax advisor. I promise to go back to my old “make it practical” mode in the next column. So here goes! Payments: Assessing Capital Gains Treatment enough to have changed contract provisions, for example, indexing the unit price for inflation. The primary tax authorities for the tax treatment of long-term timber contracts are IRS Revenue Rulings 62-81 and 62-82. Capital gains may apply to payments received by the owner equivalent to the fair market value of the timber existing on date of the contract. I’ll call this the DOC-FMV. Any payments in excess of the DOC-FMV are not for the disposal of timber, but are for the right to grow additional timber. You can think of this as rent for the land to grow more timber, and in some circumstances rent of the timber-growing stock to grow more timber. Contract provisions specifying the timing and amount of payments may affect whether payments qualify for capital gains treatment, but not the total amount that may qualify. This principle can be applied to the two basic types of carbon contracts. In the case of a contract paying a Tree Farmer to plant trees on land to which the Tree Farmer retains fee title, there’s no timber to dispose of. In the case of contracts for existing stands, there are two components. To the extent of “a disposal” of the DOC-FMV of exist- Can’t Dispose of Something That Doesn’t Exist on Contract Date This principle is the foundation of the tax treatment applied to longterm timberland and timber leases. These are rare these days, but their well-settled tax treatment informs the treatment of long-term carbon sequestration contracts. Note that I’m not referring to the typical pay-as-cut contract (also a type of lease in legal terms), under which the “buyer” has a relatively short time period to cut the timber and pay for it based on the volume cut. Think of “short” in the context of a lump-sum contract. The pay-as-cut contract is an alternative to a lump-sum contract, so the time periods typically allowed for one apply to the other. A timber contract would generally be considered long term if the timber growth and associated increase in value is substantial The Essence of Capital Gains vs. Ordinary Income Capital gains (losses) from an economic standpoint are realized by acquiring an asset, holding it for some period of time, and disposing of it. The gain (loss) is the difference between the value received when it’s disposed of and its cost or other basis at the time of disposal. While the asset is held, there William L. “Bill” Hoover is forestry professor, Extension coordinator, and assistant head for the Department of Forestry and Natural Resources, Purdue University 1159, W. Lafayette, IN 47907-1159; . Tree Farmer SEPTEMBER/OCTOBER 2009

Table of Contents for the Digital Edition of Tree Farmer - September/October 2009

Tree Farmer - September/October 2009
Table of Contents
Cover Story
A Hot Trend: Enhance Habitat with Prescribed Fire
Tools & Techniques
Woodland Security
Taxing Issues
Wildlife Matters
2008 Northeastern Regional Tree Farmers of the Year

Tree Farmer - September/October 2009