Wednesday, October 19, 2016

Via Upcountry Community Council: Tree Casualty Losses Information

Greetings, you attended the workshop on tree mortality in Amador County. I want to advise you to be sure to keep track of expenses incurred to remove dead trees. I have consulted with some specialists in taxation and these costs constitute casualty losses that can be claimed on your income tax return provided that you meet certain conditions (loss exceeds 10% of AGI Adjusted Gross Income, and exceeds $100).

I have attached an informational paper on tax consequences of insect killed trees (below). Another option to consider, that is more complicated, is to establish the decline in property value associated with the loss of trees. Of course, if you have larger property with extensive mortality that cannot be captured through salvage, that may qualify for a claimed loss as well.

Richard Harris, Ph.D
Registered Professional Forester 1961


The Tax Implications of Insect Damage
Linda Wang, National Timber Tax Specialist, USDA Forest Service

If your timber are damaged or killed by the insects, unless the situation meets the special exceptions, normal level of damage to the timber is generally not tax deductible. Such losses are considered part of the risk and cost for timber property. To be a deductible loss, historically the IRS has allowed tax deductions on insect damages to the trees under special circumstances. Most often, timber property is uninsured or uninsurable, rendering no compensation or reimbursement from the insurance. The loss of ornamental trees on residential property generally is subject to more restrictions than income-producing (business or investment) timber property even if the loss quality for a tax deduction.

Normal level of timber loss from insect damage is not tax deductible.
The economic loss of the timber from the insect damage will be reflected in the decreased value of the timber. That means your profit will be less when you sell your timber down the road and the taxes that are due will also be less.

For example, Mr. Smith owns 40-acre of woodland and intends to produce income from the timber. However, this year, some trees were gradually killed by insects over a period of several months. Because this is considered a normal level of insect infestation, the loss of timber is not tax deductible. Smith worked with a consulting forester who implemented a plan to manage the timber properly. For his tax records, he adjusted the timber volume in his forest management plan, reflecting the loss of timber volume from the insect attack. The dollar amount in his timber basis, however, stayed the same (i.e., it is not changed by the loss of timber volume from the insects). This is because the basis of his timber in his case was the purchase cost he paid for the timber property five years ago. The loss of timber from the insect damage only affects the volume part of the timber basis.

Deductible Loss from “Sudden, Unexpected and Unusual” Insect Damage (Casualty Loss)
The tax law provides a tax deduction for the damage and destruction of property that is caused by a sudden, unexpected or unusual event, that is, the casualty loss deduction. A “sudden” event is one that is swift, not gradual or progressive. An “unexpected” event is one that is not ordinarily anticipated. An “unusual” event is one that is not a day-to-day occurrence and that is not typical activity. For examples, hurricanes and fires are casualty.
Generally, insect damages seldom qualify as casualty loss for tax purpose, because such damages tend to be gradual or progressive over a period of time rather than sudden. So if the insect damage does not meet the swift and sudden requirement, one can’t claim a casualty loss deduction because it is not a casualty.

However, in special cases where the taxpayer was in dispute over whether the timber loss from insect damage qualify for casualty loss, the Tax Court had ruled in favor of the taxpayer.  Specifically, the Tax Court granted casualty loss deduction where the ornamental (“yard”) trees on residential property were killed by the Southern Pine Beetles (SPB). In the Nelson case, the taxpayer owned six acres of residential property in Texas that contained forty-eight loblolly pine trees. Twenty-four trees died within 5 to 10 days of an epidemic attack by SPB. The SPB epidemic was unexpected in the area. The court held that a casualty loss was allowable. Subsequently, the Tax Court again in the Black case determined that the infestation of trees by SPB is a sufficiently sudden event to be a casualty loss when the ornamental trees died within 30 days of attack. In the Smithgall case where the residential owner lost ornamental trees attacked by the epidemic SPB, the District Court in Georgia held that the tree loss was a casualty.   

In light of the court cases, for special situations where ornamental trees were destroyed by onslaught of beetles, the IRS issued guidance that allowed a casualty loss deduction. The death of ornamental trees 5 to 10 days following a massive southern pine beetle attack in an area not known for such massive attacks results in a casualty loss deduction. In other words, the fact that the ornamental trees on the residential property were dead after 5 to 10 days from the attack of the beetles satisfied the suddenness requirement. Also, since there were no known attacks in epidemic proportions of southern pine beetles in the area of the taxpayer’s residence prior and after the tax year, the event was both unusual and unexpected.

Note that even if a casualty loss is allowed, the deduction for the residential yard tree loss is subject to more restrictions than the commercial timber, limiting the amount of the write-off.  Any insurance received reduces the deductible loss. To figure out the amount of casualty loss deduction due to the destruction of ornamental trees by the insects on residential property, the adjusted basis in the property must be established. The calculation of the loss deduction starts with the fair market value loss, subject to the adjusted basis limit. After that, additional deduction limits ($100 floor and 10% rules) apply to personal-use property such as residence.  An appraisal on the value of the entire property before and after the casualty need to be assessed.

To deduct a casualty loss, you must be able to show that there was a casualty and be able to support the amount you take as deduction. 

Casualty loss is reported on Form 4684. The appraisal fees are deductible on Schedule A as miscellaneous expenses subject to 2% adjusted gross income reduction.

Unexpected and unusual damage in a Business
Most insect damages to trees do not result in casualty loss deduction due to the lacking of the element of the suddenness. However, in a special case involving a forest product company’s loss of trees from an unexpected and unusual insect infestation, the IRS allowed a tax deduction (which is termed “noncasualty business loss”). That is, even if a casualty loss has not occurred, a deductible business loss is available for unusual and unexpected insect damage to the timber used in a trade or business. The taxpayer in this case was a corporation that grows, manages, and harvests pine timber for use in its wood products manufacturing facilities. An unexpected and unusual attack on a stand of merchantable pine trees killed the trees. The IRS ruled that the taxpayer’s loss of timber give rise to an allowable business loss deduction when the timber became worthless and bulldozed and burned. Because such loss did not arise from a casualty, it was required to be offsetting capital gains (noncasualty sec. 1231 gains) in most cases. Also, the amount of loss is limited to the adjusted basis in the units that are lost.

In summary, most tree losses from insect damages do not give rise to a tax deduction. Typically such loss of timber from insect infestation do not result in a casualty loss when the damage occurs over a period of time gradually. But the IRS allowed a casualty loss deduction for the death of ornamental trees from an epidemic southern pine beetle attack on residential property. Note that even if the loss to the trees is deductible as casualty loss, the amount of deductions are likely not the fair market value of the timber destroyed due to the basis (usually cost) rule. In another type of special situation, the IRS has allowed noncasualty business tax deduction on timber loss from unexpected and unusual insect attack in a timber trade or business.

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