Managing Your Basis Newsletter

When you purchase forestlands, you are actually purchasing a combination of assets such as land, timber and equipment. Since these assets can be split apart and sold separately, you must go through the process of determining how much of the original purchase price should be allocated to each asset. This is called "Allocating Your Capital to Basis".

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Allocating Your Capital to Basis

While this phrase may sound intimating it is really just a way of saying that when you purchase forestlands you are really purchasing a minimum of 2 discrete assets; land and timber. In some cases landowners actually purchase a total of 4 type of assets; land, equipment, timber, and depreciable real property improvements. Because we can separate these 4 types of investments apart from the others, it is necessary to determine how much we invested in each separate investment. This way, we can determine the actual gain on selling timber apart from the land, or we can determine how much of our investment is available for depreciation (equipment).

This seemingly daunting task is not actually as complicated as you might think. However, it is absolutely necessary that you follow a series of steps, in order, to come to the right answer.

Step 1: The first step in this process is to determine the Fair Market Value of the individual assets. This is different from the purchase price of each asset. If we think about it, there is a difference between FMV and purchase price. Each of us gets a good deal or a bad deal on an item and therefore our purchase price does not always equal the FMV.

Land: Determining land value can be challenging or straightforward depending on the characteristics of the land. When we determine the FMV of land we have to consider what use determines the highest and best use of that particular parcel. Much of the forestland in the west is best suited to growing timber. However, as communities continue to grow and expand into the forested areas of the countryside, the highest and best use of forestlands often is not to grow timber, but to be subdivided and sold as housing lots. In these cases the purchaser must determine what is the highest and best use of the land and apply that value to the FMV of the land.

If the highest and best use of the property is for growing timber products, then landowners can use a formulae called the Soil Expectation Value formulae to determine the value of the land portion of the asset. In order to try that calculation out, just click here and you will be taken to that page where you can calculate your actual land SEV !

Equipment: When dealing with something like equipment the FMV is generally a reasonable estimation of market value. Think of this as a “blue book” on an automobile. It can be the “going rate” or appraised value of equipment on the date of acquisition.

Timber: The timber value on the site is also fairly straightforward to determine. We need to determine the volume of timber on the site as of the date of acquisition. If the property was acquired this year, then you can use the current volume on the site. If the asset was acquired some time in the past, then you will need to go through the process of determining the volume at the date of acquisition. We call this an “After the Fact Adjustment”.

The other item we need to determine is the value of the timber at the time of acquisition. This should be a stumpage value, that is, the value that the landowner would net from the proceeds of selling the timber less all expenses of harvest such as logging, trucking, and consulting forester fees. The State Department of Natural Resources or Department of Lands in your area often has a record of past stumpage values that are useful if you are trying to determine the value of stumpage in your area from some time in the past.

Once we have the volume of timber on the site at acquisition and the value of stumpage on the property at acquisition we can multiply them together to get the fair market value of the timber at acquisition.

Depreciable Real property Improvements: These items are physical improvements to the land that have a useful life and are depreciable in their nature. It includes items such as fences, buildings, culverts and even some roads. The critical part of these assets is that value in these accounts is depreciated each year as the asset is worn out in the production of income. Some parcels of forestlands do not include any "DRPI".

Purchase Price: At first glance, you might think that the purchase price is simply what you have paid for the parcel. However, you should add to this figure, the costs of acquisition. These normally include ordinary and necessary expenses made to purchase the parcel and include items such as: timber cruise, land survey, legal assistance, title insurance, and other similar items. The result is that it increases the total purchase price of the timber.

How You Acquired Your Forestlands

So far, we have discussed the issues of setting the original basis as if you had purchased your property. However, some landowners acquired their property through inheritance or received it as a gift. The determination of the correct original basis is influenced by how you acquired your property.

Purchased Property
If the forest landowner purchased the parcel, he or she should record the actual amount paid to acquire the asset, including acquisition costs, such as timber cruises, property surveys, legal advice, and other expenses necessary to complete the purchase of the property.
For inherited parcels, the original basis is the valuation reported on the federal estate tax return or state death tax return. If neither figure is available, record the original basis as the fair market value on the deceased's date of death. If the decedent's estate chose a special use valuation on the inherited property, then the original basis is that amount used in the special use valuation.

When the value of the forest land is determined through the fair market value on the date of death, the recipient receives a “stepped-up” basis. The “stepped-up” basis has advantages over an unchanged basis because it increases from the date of original purchase to the date of death. The higher the basis, the higher the deduction allowed when that property is sold or disposed of by the recipient.

Forest lands received as a gift retain the giver’s basis. Unlike the basis for inherited timber, this basis is not stepped up on the date the gift is received. The recipient uses the basis maintained by the giver.
The original basis changes as financial activity begins on the property. This change will modify specific accounts to reflect purchases and other types of financial activity. The term “adjusted basis” describes this change in basis value after the date of acquisition.

Putting it Together

In order to correctly calculate the original basis of each asset, a table (like the one below) should be constructed to assist our efforts. The first column is the list of assets associated with our original purchase. You can have many rows of each category. In our example, we are assuming purchased property and we are using a FMV for the land of $12,000 (calculated using our SEV calculation). There is a tractor that was purchased with this parcel that had a FMV at the time of acquisition of $8,000. The timber value on the parcel was determined by determining the volume of timber at acquisition and the appropriate value of the timber. In this example, the total value was $112,154. Finally, we will assume that there is no depreciable real property improvements so we can leave that at a FMV of zero for now.

Our next task is to total the column of FMVs for the assets. In our example, the total of these FMVs is $132,154. Now we can determine that the land represents ( 12,000 ÷ 132,154 ) or 9.08% of the total. We need to enter each of these shares of the total FMV in the column titled "% of Total". Take a look at the table and see if you can get the same answers.

Now, finally, we use the purchase price of the parcel that we calculated above. Right away you will see that it is very rare, if not unheard of, that the sum of the asset fair market values is exactly equal to the total purchase price. In this example, we will use a purchase price of $125,000, and add to that an additional $1,275 in additional fees for a total of $126,275. We can see that in this purchase the buyer got a "good deal" because the FMV of the parcel was more than the buyer paid.

Now we are ready to determine the original basis of the property. We multiply the Purchase Price by the "% of Total" for each asset and there we have it, the purchase price allocated to each of the assets on the forestland parcel. Make sure that this column adds up exactly to the purchase price. This is the set of values that will represent your original basis and then your adjusted basis in your property. This column represents where the purchase price was actually allocated.

% of Total
Purchase Price
Original Basis
1. Land
2. Equipment
3. Timber

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Kamiak Econometrics, a Division of Kamiak Ridge, LLC