Depletion is the cornerstone method of capital recovery for timber assets. It allows forest landowners to deduct from taxable income the portion of their timber investment that has been “used up” when timber is harvested or sold. In simple terms, depletion ensures that taxes are paid only on profit, not on the return of invested capital.
Purpose of Depletion
When a landowner purchases forestland, part of the acquisition cost is attributed to the standing timber. That portion becomes the timber basis—the capital investment in timber. As trees are harvested, an equivalent share of this basis can be deducted from the proceeds of the sale. This deduction is the depletion allowance.
Establishing the Timber Basis
The timber basis must be determined at acquisition and recorded in the landowner’s timber account. The basis typically equals the fair-market value of the merchantable timber at the time of purchase or transfer. Once established, this value remains constant until the timber is partly or fully disposed of.
- Each management unit or “block” of timber should have a distinct account.
- Documentation includes volume estimates, species composition, and value at the time of acquisition.
- Basis values are adjusted only when new capital is added—such as planting, thinning, or precommercial investments.
Applying the Depletion Allowance
When timber is harvested or sold, the portion of the timber account that corresponds to the volume removed becomes deductible. The percentage of the asset disposed of determines the depletion amount. For example:
- If 45 % of the merchantable volume in a timber block is sold, then 45 % of that block’s timber basis may be deducted from the sale proceeds.
- If the entire block is cut, the entire timber basis is depleted and deducted.
This calculation is formally documented on IRS Form T (Timber), which provides the worksheets for computing and recording depletion deductions.
Example
Suppose a landowner’s timber basis is $80,000. During the year, a partial harvest removes 30 % of the standing volume, generating $50,000 in gross proceeds. The depletion deduction equals 30 % × $80,000 = $24,000. The taxable portion of the sale is the gain:
$50,000 – $24,000 = $26,000 taxable income
Record Keeping
Accurate records are essential. The depletion deduction is allowed only when the basis and harvest volumes can be substantiated. Maintain:
- Volume and value data for each timber account at acquisition.
- Harvest records showing date, area, and volume removed.
- Financial statements linking sale receipts to depletion entries.
Key Takeaways
- Depletion converts the timber basis into an annual deduction as timber is sold or harvested.
- Only the portion of the asset actually used may be recovered each year.
- Proper documentation through IRS Form T preserves compliance and substantiates deductions.
- Depletion applies to both lump-sum timber sales and pay-as-cut (per-unit) contracts.