Article
Timber depletion methodology is an effective tool for tax deferral and increasing cash flow
Dec. 12, 2019 · Authored by Andrew Kaiser and Steve Fein
Are you a timber company that’s recently purchased timberland, plans to make significant investments in timberland ownership, or has significant timberland holdings that produce taxable income?
If so, your approach to timber depletion is one of the more significant planning areas to garner potential tax savings or deferrals. Various methods can be used to recover the cost basis of your investment in timber assets. The recognition of these expenses for accounting and tax purposes occurs as the timber is harvested.
At the end of the day, the goal is to establish a method that increases current cash flow on the front end by reducing your current tax liability, which ultimately frees up cash to reinvest in your operations.
Purchase price allocation
Depletion methodology starts with the original purchase price allocation of a timberland acquisition to timber, land, and other identifiable property.
Finding the appropriate balance of complexity within your approach and ascertaining the benefit provided can often be a detailed but flexible process. Here are some things to consider:
- Initial allocation of purchase price. Look at allocations of value to timber and other timberland-related assets, such as land, roads, and timber age classes.
- Determination of depletion pools. After allocating a portion of your cost to timber, you can not only divide that timber asset into merchantable and premerchantable timber, but also establish any number of viable depletion pools. Many factors can come into play when allocating cost basis to these pools, which are used to determine the expense recognized upon harvest of the timber within a pool. Examples of considerations are: species, geographic boundaries or accessibility, restrictions of rights or lack thereof, harvest plan, even or uneven age management, or surrounding economic conditions.
Decision factors
As you think through an initial purchase price allocation and the creation of timber depletion pools, here are some factors that might impact your decision:
- Carbon credits. There may be different ways to think about how monetization opportunities reflect the ability of standing timber to sequester carbon. Consider any future emission reduction projects that might impact an initial purchase price allocation.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.