Timber Rights: Why a Tax Deferred Exchange Matters
Posted by Andy Gustafson on Thu, Jul 14, 2011
Timberland owners often engage in tax deferred exchanges to save funds for higher yield acquisitions. Along with timberland, timber rights held for either business use or investment can also be exchanged and capital gains deferred for real property given proper conditions. Timber rights holders willing to maximize their benefits through such exchanges should pay close attention to state regulations and transaction structures in terms of cutting time and timber quantity limits.
What a 1031 Exchange Is
Tax deferred exchanges, also known as 1031 exchanges, are currently enforced by the Internal Revenue Service (IRS). The IRS Code Section 1.1031 states "no gain will be recognized on property held for productive use in business or investment when exchanged for like kind property held for productive use in business or investment." Property denotes real and personal property. The replacement property must be of equal or greater value than the property sold or a tax is triggered on the difference.
1031 Exchanges & Timberland
Exchanges of timberland are more common than exchanges of timber rights. According to The Nature Conservancy 2006 annual report, "About 44 million acres of privately owned forestland will be sold in the United States over the next 25 years." Timber Real Estate Investment Trusts (REITs) such as Plum Creek Timber (PCL), Rayonier (RYN), and Potlach (PCH) replace lower yield timber holdings with higher yield timber properties. With each 1031 exchange, consideration is given to the nature and character of conveyed rights, likeness of physical properties and period or duration of interests. The Court has interpreted the "like kind" requirement liberally meaning an interest in real estate, whether improved or unimproved is like kind to other interest in real estate as defined by state law.
1031 Exchanges & Timber Rights
The right to cut and remove standing timber for a limited period of time is not eligible for 1031 consideration. In Oregon Lumber Company v. Commissioner, 20 T.C. 192 (1953), the Court reviewed a case where the taxpayer transfered interest in timberland to the U.S. government in exchange for the right to cut and remove timber in a national forest of equal value. The Court disallowed the 1031 exchange given the right to cut and remove timber were personalty of the property rights secured from the sale agreement and not like kind real property rights under Oregon State law.
Carve outs or a bill of sale are typically for a limited period of time and quantity. The rights conveyed are not like kind to those of a fee interest in real property. If the state recognizes timber rights as real property and the transaction can be structured to permit perpetual cutting in unlimited quantities, the transaction would be eligible for a 1031 exchange. A 30 year lease is recognized as real property by the 1031 code implying the ownership of the land is not conveyed while the timber is cut, removed and reforested or as stipulated by the lease agreement.
Care should be taken when selling timber rights. Defining how the land is to be reclaimed with definitive steps is important to avoid a sea of tree stumps, tree tops and aftermath of logging roads. It is strongly recommended that you engage a Certified Forester and attorney when considering a lease or sale of timberland and timber rights.
What questions do you have regarding timber rights?
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