When buying or selling land, it is important to consider the tax implications of any standing timber on the property.
Standing timber refers to a block of trees that will yield saleable timber. The Inland Revenue Department (IRD) excludes fruit trees, ornamental or incidental trees. However, standing timber does include native bush, shelterbelts and erosion control planting.
When standing timber is ‘disposed of’ the income is taxable, therefore it is important to know how it will be taxed and how much it will cost you.
Taxable income arising from the disposal of standing timber is most evident when there is a land sale but can also occur on the death of an owner or a resettlement of a Trust.
When purchasing land with standing timber on it, it is in both parties best interest to ensure the total value of the trees is recorded in the Sale & Purchase agreement. For the purchasers, this value will be deemed the cost of timber and can be claimed as an expense in the future when trees are sold or harvested. If no value is stated in the agreement, then at harvest time there could be no cost/deduction to claim against this income. For the vendor, this value will be income at settlement date.
It is important to note that the purchaser could obtain a valuation at the time of purchase of the farm, if the agreement is silent on the value of the trees. This will then give the purchaser a cost value to offset income when the forest is harvested. In order to do this, ensure you retain any valuation agreed upon and the methods undertaken to value the trees.
Under this circumstance, the vendor could become liable for a deemed sale of trees based on the purchasers valuation.
Overall if the agreement includes a value, both parties know where they stand from a tax perspective for the trees.
The taxable income arising from the sale of the trees is the sale price of the timber less any costs not already claimed as an expense i.e. the purchase price of the trees and harvesting costs.
There are special rules for when income from trees is assessable to the IRD. Under section EI 1 of the Income Tax Act 2007, the IRD allows you to spread the proceeds over the year of disposal and any one or more of the previous three income years from the year the sale proceeds were realised. This is done by an application to the IRD within 12 months of the end of the income tax year in which the sale occurs. If the application is approved then you must also apportion any allowable deductions for the cost of the timber over the same periods.
The IRD has concessions and you will not be disadvantaged by reassessing prior income tax year returns as a result of spreading the income backwards.
The tax savings from opting to spread the net tree income depends on your level of taxable income. If you haven’t used up your lower tax rates in the years available to spread the income then there will potentially be tax savings available.
An example of this is:
- 2018 income year trees are sold and the taxable income less expenses totalled $50,000
- You apply to spread some or all of this profit over the prior three income tax years
- Your taxable income in was 2016 $20,000 and in 2018 it is $100,000 (excluding the $50,000 timber income)
- You apply to spread half of the timber income to the 2016 year and the remainder in the 2018 tax year
- Overall tax saving would be approximately $3,875
There are other important provisions to consider surrounding stander timber that have not been discussed in this article, such as carbon tax credits and the emissions trading scheme.
For further information, please do not hesitate to contact our team at CooperAitken Ltd.