Sec. 631(b) and the taxation of standing timber sales.

• Author: Cody, Reade

The federal tax rules that apply to timber growth and harvesting are, in many respects, counterintuitive to almost every "rule of thumb" related to the Internal Revenue Code. Timber is its own, special category of activity. It is separate from other ordinary trades or businesses selling stock in trade and the general farming tax rules. Its treatment is even different from the general tax principles that apply to other natural resources.

Special timber rules are contained in Sec. 631, which applies generally to gain or loss from timber, coal, or domestic iron ore. Specifically, under Sec. 631(b), gains or losses from the sale of standing timber shall, solely for purposes of determining character of income, be considered gains and/or losses from the sale of business use property as defined in Sec. 1231 (i.e., capital gain property used in a trade or business), as long as the taxpayer held the standing timber for more than one year. Basically, sales of standing timber with a short-term holding period (one year or less) are considered ordinary trade or business or royalty income, or short-term capital gain, but gains on timber sales with a long-term holding period are allowed favored capital gains rates, while losses are deemed ordinary.

Corporations, Individuals, and Tax-Exempt Entities

C corporations: The distinction between ordinary income or loss and capital gain or loss does not benefit all taxpayers. The most glaring example is a C corporation, which does not receive different treatment between ordinary income or loss or capital gain or loss (although some benefits may lie in losses being Sec. 1231 losses rather than Sec. 1221 losses, this is outside the scope of this item). Generally, regular, domestic C corporations are indifferent as to whether Sec. 631(b) applies to timber sales, since no lower tax rate applies to capital gains.

Individuals: Individuals who hold timber for use in a business, including U.S. citizens or residents and nonresident aliens, however receive a definite benefit. If they were dealing in almost any other raw material, the longer holding period would most likely not change the view under the Code that the raw material is "inventory," and thus is not an invest-ment--thus, any income derived from the sale of this "inventory" would be ordinary trade or business income of a dealer in stock or trade. Given the favorable rules under Sec. 631(b), however, individuals enjoy the good result of long-term capital gains...