Potential Tax Incentives for Timber Investments
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The commentary below is for information purposes only. It is not tax advice or advice of any kind. Please consult with your tax professional for advice regarding capital gains and the tax treatment of timber in particular.
While nontaxable institutional investors have long been interested in timberland investments, investments in timber can be inherently attractive to taxable investors as well, due to certain unique tax attributes.
Given timber’s historically attractive returns coupled with unique tax incentives, timberland investments could potentially yield higher after-tax returns for taxable investors when compared to more traditional investments in other major asset classes, such as equities and fixed income.
- What Is the Tax Rate on Timber?
- How Is Timber Taxed Vs. Other Asset Classes?
- Positive Cash Flows and Passive Tax Losses
- Final Thoughts
What Is the Tax Rate on Timber?
Timber’s tax efficiency comes down to one key detail: Gain from the sale of timber, which generally represents most of the investment return, may qualify for long term capital gains treatment.
What are long term capital gains? The IRS qualifies profits realized from the sale of an investment that’s been owned for at least one year as long term capital gains.
Most of the revenue and return from a typical timberland investment—upwards of 90% of the total—is generated by the sale of harvested timber and the sale of the land. Under the U.S. tax code, revenue from these sales is expected to fall under long term capital gain tax treatment.
This is because timber is recognized as an asset with important societal benefits, from contributing to clean air and water to supporting rural economies. It also has long time horizons—even fast-growing pines take 30 years to mature. Capital gains tax treatment is meant to incentivize investments in this crucial asset.
It’s important to note that the tax provisions of timber can differ slightly depending on your ownership structure, but investors are often able to take advantage of the lower rate. Deductions and depreciation (called depletion in the timber industry) do come into play and are typically handled by your investment manager and tax professional.
How Is Timber Taxed Vs. Other Asset Classes?
Taxes on a timberland investment made by an individual investor may amount to 15-20% of the total pre-tax return. This compares with an ordinary income rate of up to 37% for short term assets and some other types of investment income.
A fixed income investment, for example, can be subject to income tax rates, given that interest payments, which make up a significant part of the return, are taxed as ordinary income. A real estate investment that achieves a significant portion of its return from rental income may have that income taxed as ordinary income.
Positive Cash Flows and Passive Tax Losses
Cash flows from timber investments are usually intermittent, based on periodic harvests of standing timber. At the end of a hold period, the timberland is sold, realizing the value of the remaining standing timber as well as that of the underlying land.
Most of the revenue from most timberland investments is attributable to the sale of the standing timber, which is generally subject to capital gains treatment after the first year of ownership, per Section 631(b) of the Internal Revenue Code.
Income from the sale of the land is subject to the same taxation rate, again, so long as it’s been held for at least a year. Typical institutional holding periods for timber properties are 10, 15, or even 20 years.
Additionally, smaller amounts of revenue from hunting leases and other secondary sources of revenue which would normally be subject to ordinary income tax treatment are often offset entirely by operating expenses related to the forest management activities, such as property tax payment, road maintenance, etc.
Timberland investments have seen tremendous growth over the past 40 years, driven in large part by historically attractive returns and portfolio diversification benefits. Although investment in the asset class has previously been dominated by nontaxable institutions, these attributes, plus the unique tax incentives of owning timberland, suggest that individual investors may benefit from including timberland in their portfolios.
The information above is not intended as investment advice, tax advice, or a recommendation to invest in any securities. Rules related to short and long term capital gains are subject to change. Consultation with your tax professional is strongly recommended prior to investment. Past performance is no guarantee of future results. For additional risk disclosures regarding land investing and the risks of investing on AcreTrader, please see individual farm offering pages as well as our terms and conditions.
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