College of Natural Resources, UC Berkeley

The S.J. Hall Lecture in Industrial Forestry

Taxes and Forest Management

William K. Condrell


Recent surveys of timber consumption indicate that demand for forest products in this country could double by the end of the century. Unless present levels of forest investment and management are dramatically increased, that demand will not be met.

Public timberlands, which comprise only 28 percent of the forest lands suitable for commercial timber production in the United States, cannot be counted on to reduce the supply-demand gap. First, as demand for wilderness and recreation areas intensifies, more and more federal timberlands are being taken out of timber production. Second, there is no apparent willingness on the part of state or federal governments to make the investments necessary to increase our timber supply.

If public timber cannot be relied upon to reduce the projected supply-demand shortfall, then forest management and investment decisions by private owners become all the more critical.

Seventy-two percent of the U.S. forest lands suitable for timber production are owned by the private sector. Of that 72 percent, 82 percent are owned by approximately 4.5 million private individuals.

Many factors determine the kind of forest investments made by those 4.5 million people but clearly among the most important is timber tax policy at both the federal and state level. In terms of taxes which impact most heavily on the investment decision of timber owners, the three most significant are the following:

  1. Federal income taxes on the increase in value which occurs between the time and seedling is planted and the time it is harvested. In this regard, capital gains treatment of timber assumes great importance;

  2. Estate and inheritance taxes, which can make it difficult to maintain timber in family farms and estates; and

  3. Ad valorem property taxes, which are the most common form of local government taxation of timber.

Timber tax policies determine to a considerable degree, whether forest lands will be protected and managed productively, or whether they will be forced into activities other than growing trees. There is a need for clear identification of our public policy goals and a rational and coherent timber tax policy to achieve them. What we have now, unfortunately, is diverse, uncoordinated decision making at the state and federal level, without full appreciation of the consequences of those decisions for one of the nation's most critical natural resources.

This article will focus on those timber tax policies, analyzing the impact of the three major taxes on forest management and investment decisions.

Taxes and Forest Growth

Recent studies indicate that because of the long growing period involved for timber, even small changes in annual taxation have an immense effect on long-term growth.

Timber taxes are particularly crucial to forest investments due to the fact that, historically, return on investment in the forest products industry has been far below the average of other industries. Federal Trade Commission reports indicate the return on lumber, paper and allied products from 1966 to 1975 was 5.8 percent compared to a figure of 6.5 percent for all durable and nondurable goods. According to university and government studies, this low rate of return is found in all sections of the country and for all types of ownership.

An analysis of the specific types of timber taxes shows a clear relationship between timber taxes on the one hand and forest investments and long-term growth on the other.

With respect to the impact of federal income taxes on timber investments, capital gains treatment was first permitted for all timber transactions in 1944. This change in tax law was followed by a dramatic increase in forest investments. However in 1969 the capital gains incentive was substantially reduced through increase in tax rates and since that time, although there has not been enough time for adequate data to be developed, there is an indication that, as would be expected, there has been a substantial decline in timber investment. This is discussed in greater detail below.

Regarding estate taxes, the Estate and Property Taxation Committee of the Forest Industries Committee on Timber Valuation and Taxataion recently completed a detailed analysis of the impact of various tax law provisions that adversely affect investment in timber growing. The report concluded that by far the worst effect is exerted by the provision in the 1976 Tax Reform Act which requires an heir to "carryover" the basis of the prior owner in the inherited property. In fact, according to the study, owning timber has become a losing proposition due to the carryover basis provision when one considers the passage of timberland through several estates.

The analysis of the Estate and Property Taxation Committee was based on a typical timber investor whose timber estate was transferred at death through a normal chain of inheritance until it reached his grandchild. The report considered several alternative investments: a six percent taxable security, a seven percent tax free security and timber. It found that if a $150,000 investment is made in an asset providing a six percent annual ordinary return and appreciating six percent annually in value, the rate of annual increase in asset value after passing through two estates and using the carryover basis rule is 2.25 percent. A similar investment in seven percent tax free securities results in a 2.38 percent annual increase. However, in contrast, a $150,000 investment in timberland yields only 0.28 percent annually.

These figures indicate that as long as alternative investments are available which have less risk and result in greater return to the ultimate beneficiaries, there will be an incentive against adequate forest investments.

The impact of ad valorem taxes on long-term forest investments is also extremely significant. In 1976, the Stanford Research Institute completed a study on this subject. Based on the data received from the owners of large private forests, the Stanford Research Institute found that property and yield-type taxes on timberlands and timber accounted for about one-third of their total forestry-related expenses. Moreover, property and yield-type taxes on timberlands and timber increased by about 195 percent between 1962 and 1972.

The report concluded that property taxes can have a strongly negative impact on new investments in timber:

    ... with respect to making new investments in timber growing, the effect of the increasing tax burden is to reduce the attractiveness of timber growing. The ultimate effect is to take some lands out of managed timber production-whether the contemplated in-vestment is to be made on lands already owned or on lands that might be purchased. The mechanism by which this occurs is a lowering of the price that can be paid for bare land on which to grow wood. As that price drops, nonforest uses are better able to compete for timber-growing sites. The marginal sites become submarginal and are no longer used for commercial timber-growing purposes.

Income Taxes

Approximately 4.5 million private individuals own 59 percent of the land in the United States that is suitable for commercial timber production. Another 13 percent is owned by industries engaged in manufacturing forest products. With 72 percent of our nation's forest lands in private hands, federal income taxes have a great impact on timber investments.

Timber has always been treated as a capital asset for purposes of taxation. However, prior to 1944 the capital gain tax laws were very narrowly applied to timber with the result that there was little financial incentive for timber owners to manage their timberlands for continuous production of timber. If the timber owner practiced sustained-yield management, cutting only a small portion of his timber each year, he was taxed at ordinary income rates on his gain. If, however, he liquidated his entire stand at once, the gain was taxed at capital gains rates.

These pressures to liquidate timber holdings resulted in low levels of forest management and investment and considerable economic instability in areas dependent on the forest products industry. Barren, devastated forest lands were the result of a tax policy which promoted a "cut-out-and-get-out" philosophy among timber operators.

In 1944 Congress reversed this tax policy by applying capital gains treatment to timber transactions which are compatible with good forestry practices. This action was followed by the most dramatic growth developments in the history of American forestry. Prior to 1944, seven billion cubic feet more timber was harvested than was grown annually. Since 1944, we have grown an average of over three billion cubic feet more than we harvested each year, a substantial net gain. Annual plantings on private lands have increased from practically zero to over one million acres per year.

The change made in 1944 was based on the recognition of many factors:

  • That capital investment in forest resources is necessarily long-term, since seedlings take from 30 to 75 years to produce timber for lumber and plywood and 20 to 30 years for pulpwood.

  • That timber's value can be adversely affected by uninsurable risks, such as weather, insects, disease, and fire. In 1976, for example, forest fires destroyed 5,110,000 acres of forest lands in the United States.

  • That with new timber growth occurring at the rate of only four to seven percent a year, the rate of return on timber investments is so low that new investment is attracted only with difficulty and is inadequate to meet the nation's long-term requirements for timber.

Recent Developments
Prior to 1969, the effective capital gain rate for individuals was 50 percent of the ordinary rate, with a maximum of 25 percent. For corporations, it was a flat 25 percent. Changes made by Congress in 1969 and 1976 have been discouraging. First, the maximum 25 percent capital gains rate for individuals was removed, resulting in a maximum effective capital gains rate of one-half the ordinary rate, or 35 percent. For corporations, the capital gains rate was increased to a flat 30 percent. Second, the minimum tax was made applicable to individual and corporate capital gains. For corporations, this resulted in an additional capital gains tax of roughly one percent. For individuals, the impact of the minimum tax was far greater, resulting in a maximum capital gains rage of 39.875 percent. When you consider the effect of treating one-half of long-term capital gains as a preference item for computing the maximum tax on earned income, the maximum tax rate on individual capital gains is 49.125 percent.

Since capital gains rates were increased in 1969, there is some evidence of a falloff of investment in timber growing nation-wide. In Alabama, for example, 65 percent of the land being harvested is not being adequately restocked.

The President's Advisory Committee on Timber and the Environment estimated in 1973 that 78 years would be required to restore already unproductive forest lands to productivity, based on the 1971 level of planting. If capital gain taxes are allowed to remain at these high levels, the result will be severe wood shortages, sharp price rises, dependence on inadequate substitutes, and higher imports. It would be a severe blow to our balance of payments.

Congress appears to be recognizing the need for a substantial reduction in capital gain tax rates. The Revenue Act of 1978, which the Congress is currently considering, is quite likely to include such a reduction.

Estate Taxes

In recent years federal legislators have become increasingly aware of the impact of federal estate taxes on timber investments. Estate taxes often force individuals to take inherited land out of resource production to obtain immediate income for estate tax payments. This factor is a significant restraint on our nation's ability to attract the investment needed to sustain our private forests.

The impact of estate taxes on timber investments is all the more apparent when one analyzes the ages of those private individuals who own timber in this country. According to a survey conducted by the American Forest Institute, 37 percent of the owners of private timberland in 1972 were over 60 years old and 28 percent were between 50 and 60 years of age. These statistics indicate that 65 percent of the owners of private forest lands could be involved in estate tax proceedings between now and the end of the century. This will occur precisely at the time when the pressure on private lands to meet this country's wood needs will be most intense.

The Tax Reform Act of 1976 made many major reforms in federal estate and gift tax laws. Most of these changes are beneficial to the private owner of timberland.

Increase in Exemption and Marital Deduction
The 1976 Act abolished the separate rate structures for estate taxes and lifetime gift taxes and instead combined them in a single rate structure. Effective January 1, 1977, the $60,000 estate tax exemption and the $30,000 lifetime gift exemption were abolished and replaced by a single tax credit covering both estate and gift taxes. The tax credit is to be phased in over a five-year period, starting at $30,000 in 1977 and increasing to $47,000 in 1981.

For tax purposes, the difference between an exemption and a credit is very significant. An exemption reduces the amount on which the tax is based; a credit on the other hand, is subtracted from taxes actually owed. For example, a $30,000 credit is equivalent to an exemption of $120,666; a $47,000 credit is equivalent to an exemption of $175,625.

Perhaps the most important change in the 1976 Act is the increase in the so-called "marital deduction," i.e., the amount of the deduction which is permitted an estate for property passing to the surviving spouse. Under prior law, the estate tax marital deduction was 50 percent of the adjusted gross estate. Similarly, there was a gift tax marital deduction of 50 percent of lifetime tax free to a spouse.

Under the 1976 Act, the new estate tax marital deduction is the greater of $250,000 or 50 percent of the adjusted gross estate. The effect of this change is to increase the marital deduction for estates of less than $500,000; the marital deduction for estates of $500,000 or more remain the same. The gift tax marital deduction is the greater of $100,000 or 50 percent of the gift between spouses.

Change in Valuation Rules
Under prior law, one of the biggest problems facing an administrator of an estate containing timberland was the question of establishing the value of the estate. The former rule was that the property had to be valued at its "highest and best use", even if that exceeded the property's value in its current use as timberland. This valuation often forced the administrator to cut and sell the timber in order to pay the estate tax obligation based on the higher valuation. Such an outcome is contrary to the goal of achieving maximum productivity from our nation's private forests.

The 1976 Act permits the administrator of an estate to value real property based on its current use rather than its highest and best use. This special valuation is only available to farms (which expressly includes woodlands) and other closely held businesses, and cannot reduce the decedent's gross estate for tax purposes by more than $500,000. Moreover, the special valuation is subject to several other conditions. The most significant for timber owners is the requirement that there must have been material participation in the operation of the farm (including timberland) or other business by the decedent or a member of his family in five out of the eight years immediately preceding the decedent's death. This is significant for timber owners because their participation in the management of the timber may be relatively slight compared to other investments. The Internal Revenue Service has recently issued proposed regulations to clarify the definition of material participation.

Carryover Basis Rule
The 1976 Act included an adverse change in estate tax laws, namely, the new "carryover basis" rule.

Under prior law, an heir's basis in inherited property was generally "stepped up" to the fair market value of the property at the prior owner's death. The net effect of this step up in basis was that appreciation during the life of the decedent was never subject to income tax.

Under the 1976 Act, heirs no longer receive this "stepped up" basis for inherited property. Rather, the decedent's basis is "carried over" and, with certain adjustments, becomes the heir's basis. To soften the impact of this new change, it is phased in so that an heir is only taxed on the appreciation of inherited property which occurred after December 31, 1976,

The Senate Finance Committee has approved a bill, H.R. 6715, which contains the Byrd-Doyle amendment delaying implementation of the new rule until December 31, 1979.

The purpose is to allow Congress to fully consider the impact of the new carryover basis rule. The full Senate is expected to vote on the delay later this year.

Ad Valorem Taxes

As discussed above, ad valorem property taxes can have a major negative impact on timber investment in this country. The effect is most strongly felt by nonindustrial private timberland owners (generally small owners) who own 59 percent of the commercial timberland in the United States.

Unduly high property taxes can result in a timber owner simply cutting his timber earlier than good forest management would dictate, in order to convert his land to a more financially rewarding activity. Such a result is certainly not in accord with the public policy goal of growing more wood.

In addition, there are other serious deficiencies in the use of the ad valorem property tax as the basis of taxation of forest properties. Perhaps the foremost of these shortcomings is the difficulty of establishing an accurate value on a given tract of timberland.

The first problem is to determine the volume of timber involved. This process is very imprecise. No two acres of timber are alike. The volume of timber on different acres will vary greatly based on the productivity of the site, age, species, quality, growth rate, and density. Even if volume is determined, it may be that the timber is not economically available for commercial use because it is not feasible to construct roads leading to it. The cost of such timber assessments can be quite high. The Stanford Research Institute article noted a cost to the State of Oregon of nearly $1 million annually.

Assuming timber volume can be determined, the next step is to establish the timber's fair market value. There are two principal means used to establish fair market value: the transaction evidence approach and the income approach. Both have major inadequacies.

Under the transaction evidence approach, the value of a specific tract of timber is established based on current sales of comparable timber. There are several problems with this approach. First, no two timber sales are the same. Prices may vary greatly based on the needs of the buyer, length of time until harvest, cost of transportation and logging. Second, while evidence of current transactions is helpful in determining the value of timber to be harvested in the near-term, it fails to account for the long growing period for timber. Third, it is difficult to use this method for large tracts of timber because most states have few sales of large timber properties to use as evidence of comparable value.

The income approach determines fair market value based on estimates of the present worth of income that can be expected in the future from forest property. This method avoids the problem of attempting to make comparisons with other timber transactions but it replaces that problem with others that are equally formidable, namely, the practical difficulty of predicting future income, which involves projections of future costs and prices.

Because of the problems with current valuation methods and their desire to reduce ad valorem taxes on timber properties, many local decision-makers have sought techniques to modify the ad volorem system. One recent trend is toward assessment based on "current use" rather than the more traditional "highest and best use". According to the Stanford Research Institute, such laws have been enacted as an option in about 25 states and more states are moving in that direction. The result of such enactments will likely be a reduction in current or prospective tax liability, particularly in areas subject to intense real estate pressure.

There are some who believe that timberland is just like any other property and should be taxed accordingly on a full retail value basis (an unmodified ad valorem system). Fortunately, however, most observers recognize the special needs of timber growing and desire to treat timber uniquely. They recognize that property taxes discriminate against long-maturing investments, such as timber.


Despite the wide diversity of decision making involved in timber tax policies and timber growth, there is a general predisposition to treat timber as the special resource it is. This applies in our country at the state and federal level and also in all industrialized countries of the world.

In 1973, Zebulon W. White conducted a study of "Taxation of Forest Land and Timber in Other Countries". He studied timber tax policies in the United States, West Germany, France, Great Britain, Sweden, Finland, Norway, Australia, Switzerland, Holland, New Zealand, Brazil and Japan. He found that in every country there was some combination of incentives to timber growers. He writes,

    There is a general understanding that timber producing property is a unique capital asset and that proper tax incentives play a primary role in keeping it productive, both for the owner and for the national welfare.

It is critical that we continue to recognize the need for preferential tax treatment of timber. This is true in all fields-income, estate and ad valorem taxation.

If is equally important that foresters, students of forestry, and others who understand these matters communicate their views to national policy makers.

Introducing: William K. Condrell

William K. Condrell
Mr. William K. Condrell has practiced law for over twenty years, primarily in the Washington, D. C. area, and is now a partner in the law firm of Steptoe and Johnson. He has been General Counsel of the Forest Industries Committee on Timber Valuation and Taxation for over fifteen years.

From 1950 to 1954, he worked in the Executive Office of the President, serving both in the Office of Management and Budget and in the Office of Defense Mobilization.

Mr. Condrell is both a lawyer and a certified public accountant. He did his undergraduate work at Yale, received a Master's Degree from M.I.T. and graduated from Harvard Law School in 1950.

He is a member of the American Bar Association and the American Institute of Certified Public Accountants. He has taught courses such as Economics, Accounting and Statistics at various schools including M.I.T., Boston College and George Washington University.

He lives in Bethesda, Maryland, with his three sons, Paul, Bill and Alex.