University of Maryland Extension

Stewardship Planning - Taxes

Calculating costs

Taxes: Reducing Hidden Costs

Taxes are a real, but sometimes hidden cost to anyone who owns forest land. Forest landowners in Maryland can increase the financial return on their forest stewardship efforts by using existing laws and programs to minimize property, income, and estate taxes. The following information highlights some of those laws and programs. Forest landowners are encouraged to investigate these and other tax and estate planning considerations.

 

 

Keep Good Records!

The importance of keeping good records on your property cannot be overemphasized. Accurate records are critical to responsible stewardship and to the future of forest land as well as to the proper reporting and documentation of income and expenses for tax purposes. An excellent record keeping and account book entitled the Forest Management Account Book (Extension Bulletin 360-A) can be purchased from your county extension office.

 

 

Property Taxes

These are paid yearly to county government. Forest landowners can receive a lower property tax assessment in one of three ways: a) through a forest management program, b) enrolling in an agricultural district, or c) donating/selling a conservation easement.

A) Forest Management Programs

To reduce property taxes, a forest landowner must first have a forest stewardship plan for a minimum of five forested acres. The plan can be developed to meet the landowner's objectives by a Maryland licensed forester--a Department of Natural Resources forester, a private consulting forester, or an industrial forester. This plan must meet the basic requirements for the Forest Stewardship program (minimum five forested acres) or the Tree Farm program (in Maryland, a minimum of ten forested acres). The Maryland Department of Assessments and Taxation offers landowners two assessment options: Forest Conservation Management Agreement (FCMA) or the Forest Management Plan (FMP). Both FCMA and FMP reduce property taxes but usually do not affect the fair market value used to assess an estate for taxes.

Forest Conservation Management Agreement (FCMA) - Any owner of five or more contiguous acres is eligible to enter a FCMA with the Maryland Department of Natural Resources. House sites, crop land, and other non-forest open spaces are not eligible, but land recently planted to forest tree seedlings or Christmas trees is eligible one year after planting. The FCMA is based on a forest management plan developed by a Maryland registered forester in consultation with the landowner. Certain forest management activities are outlined to be completed during a minimum period of fifteen years. The plan and associated activities can be adapted with agreement by the forester and it can be extended. It is a legal agreement recorded in land records, binding for fifteen years, and can be renewed. In return, the property is assessed at $100/acre regardless of where it is located in Maryland. The valuation is frozen at that level for the fifteen years of the agreement. If the plan is not followed for the full fifteen years, penalty taxes will be owed for the non-compliant year.

The FCMA involves several fees:

  • A management plan development fee of $175-$225, depending on the acreage; this fee is not eligible for cost sharing if the plan is developed by a DNR forester;
  • An entry fee that is equal to 0.55 percent of the assessed value, but not less than $50; and
  • An inspection fee equal to 20 percent of the entry fee but not less than $100, for an required inspection by a DNR forester every five years.
  • Information on FCMA is available from the local DNR forester or the county Extension office.

Forest Management Plan (FMP) differs from an FCMA in that it is not a legal agreement and does not involve an entry fee. As with the FCMA, a Maryland registered forester, in consultation with the landowner, prepares a forest management plan. The plan is submitted by the landowner to the county assessor. Most county tax assessment offices require an inspection every three years by a Maryland registered forester. Many consultant and industrial foresters do not charge an inspection fee for existing clients. Land under FMP is valued at $150/acre. This value is not frozen and could change during the three years of the agreement, but in the past these changes have not been significant.

The FMP has these fees:

  • Management plan development fee. Some industrial foresters will develop plans for their clients in exchange for first refusal on the sale of any timber products. Under the currently-unfunded federal Stewardship Incentive Program (SIP), the cost of having the plan developed by a consultant forester qualified for 65 percent cost-sharing.
  • Inspection fees, if inspections are required by the county tax assessment office, depend on whether the inspection is done by a DNR, consulting, or industrial forester.

The difference between the tax bills of the FCMA and FMP options can be small. However, the FMP differs from the FCMA in these respects:

  • No entry fee;
  • No legal attachment in the land records; and
  • Shorter time period.

Some county assessment offices may be reluctant to acknowledge the FMP option, but this is a state tax assessment option that counties are bound to honor. For more information, contact the county tax assessment office, DNR forester, or a consultant or industrial forester. A list of registered consultant and industrial foresters is available from the local DNR forester or the local Extension office. Landowners need to assess their situations to determine whether FCMA or FMP is more advantageous. DNR foresters have computer software to analyze a forest landowner's information to determine which agreement would be more beneficial.

 

B) Agricultural District

Forest land is eligible for enrollment in an agricultural district, thereby reducing the land assessment and the property taxes. A minimum 100 acres (lesser acreage if adjacent to an existing agricultural district) and a natural resources conservation plan, developed by the Natural Resources Conservation Service in consultation with the landowner/manager, are required. Eligibility is based partly on soil types. Soils that do not meet the requirement for agriculture use may meet the requirement for forestry use and be eligible. Enrollment in an agricultural district is for renewable five or ten-year periods, depending on the county. An agricultural district is an agreement to continue agriculture/forestry operations. It provides some protection against nuisance complaints and is a prerequisite for selling a conservation easement to the Maryland Agricultural Land Preservation Foundation. Contact the county planning department.

 

C) Conservation Easement

Forest land that is eligible for the sale or donation of a conservation easement most likely also will qualify for a reduced assessment. Consult the University of Maryland's Center for Agricultural & Natural Resource Policy fact sheet, Estate Planning and Conservation Easements, for more information. Contact the Maryland Environmental Trust (donation of easement) or the Maryland Agricultural Land Preservation Foundation (sale of easement).

 

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Timber Taxes

The sale of forest products can result in increases in tens of thousands of dollars in income in that year. There are a number of strategies to minimize timber taxes. The most common strategies to remember are:

Keep records of all your forest land-related activities on your property using the Forest Management Account Book (Extension Bulletin #360-A) available from University of Maryland Extension.

Use the services of a licensed consultant forester to act as your agent in the timber sale. The University of Maryland Extension Bulletin #367, Marketing Forest Products, provides more detail on how to properly market forest products.

Claim timber sale income as capital gains, not ordinary income which has a higher tax rate and is subject to 15.3% self-employment tax.

Have a forester calculate the basis value of the timber which can be subtracted from the income received from the sale of forest products.

Remember to subtract the expenses associated with the sale, such as the commission paid to a consultant forester, equipment, travel, meals, etc.

Locate an accountant who is familiar with the specialized are of timber taxes.

Use the National Timber Tax Website, consult the USDA Forest Service’s Forest Owner's Guide to the Federal Income Tax (Agriculture Handbook 718), or Penn State University’s Timber Taxation: A General Guide for Forestland Owners.

 

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Estate Planning

Federal estate taxes are paid by the heirs when the owner of an estate dies. Unfortunately, planning ones estate requires accepting one's own mortality and communicating with the heirs about the future of the property. Estate planning for woodlands can be very challenging since the planning horizon for most forests typically exceeds a lifetime. Many forest landowners invest much time and effort into the management of their forest during their lifetime, but fail to plan for what will happen to the property beyond their tenure.

Forest land has appreciated at a rate that far exceeds inflation in many parts of the country and a family that always thought of themselves as poor may discover they have an enormous equity in forest land. Many forest landowners make the mistake of assuming the assessed value of the property for property tax assessment (which is based on current-use for forestry or agriculture) is the same as its assessed value for estate taxes. When the remaining spouse of property dies, the value of the estate is based on its full value, which includes it value for development. While the property may have been purchased many years ago for a low price, the estate tax is now based on current value for development, which may be many times the original cost. This is a common problem in the rapidly developing landscape of Maryland.

Resource: Estate Planning for Forest Landowners: What Will Become of Your Timberland? USDA Forest Service, 2009.

 Take Advantage of the Unified Tax Credit for Each Spouse

Estate taxes are a problem because they are very high compared to income taxes. In the past, the first $600,000 of the estate for each spouse was excluded from taxes, which is known as the unified tax credit. However, after the first $600,000, the tax starts at 35 percent and rises to a maximum of 55 percent. The unified credit can be taken by each spouse, so that with good estate planning, two spouses could exclude a total of $1.2 million from the estate. If the first spouse dies and does not use the unified credit then the remaining spouse inherits all of the estate with no taxes. However, when the remaining spouse dies, only $600,000 can be excluded from the estate, not the $1.2 million. A major opportunity is lost if spouses do not take advantage of the unified credit. Hence, good estate planning is necessary while both spouses are still alive.

In situations where the estate owner(s) did not have an adequate estate plan, heirs may be left with an large estate tax obligation that they are not prepared to pay. Heirs are sometimes forced to hold a quick sale of property or the timber in order to pay the tax and to satisfy the urgency of the IRS. Many years of careful forest stewardship by the original owners can be lost.

 Steps in Estate Planning

The first step in estate planning is to learn more about the subject. Estate planning is usually done in anticipation of dispensing property to others, with three things in mind: 1) to continue a forest-management legacy and to keep the land intact and in the family; 2) to minimize the cost of transferring ownership when the estate is dispersed; and 3) to provide for dependents and heirs.

Perhaps the most difficult part of this process is to talk with the heirs and make decision such as who will be the executor of the estate, and what their plans are for the future. Are the heirs really interested in holding on to the property and continuing the activities of their parents? Good communication among the owners and the heirs is essential. The estate planning team should include your consulting forester, an estate planning attorney, an insurance underwriter, your personal representative or executor, and possibly, one of your children. An accountant may also be part of the team, if necessary.

It is likely that your local attorney you have worked with for years may not be qualified to handle your estate planning needs. Finding a qualified estate planning attorney is critical. There are several estate planning tools to help you accomplish your objectives. They include trusts, insurance, corporations, conservation easements exchanges, and other tools. A good source to help locate a qualified estate planner is the American College of Trust and Estate Counsel. The college requires members to have a minimum of ten years of experience in estate planning and sound local and national references. Not every estate planner is a member of the college.

The 1997 Taxpayer Relief Act

The 1997 Act provided some very positive changes that will benefit forest landowners. These include increases in the unified tax credit from the $600,000, inflation indexing of annual gifts, use of installment payments of estate taxes, and the ability to donate a conservation easement after the owner has died under certain conditions. There are other changes as well that you should investigate. The next section provides some information on these changes. Use the references at the rear of this chapter to educate yourself about estate planning. Contact your local Cooperative Extension office or state extension forester for educational information.

Year

Unified Tax Credit - Cash Equivalent

1998

$625,000

1999

$650,000

2000-2001

$675,000

2002-2003

$700,000

2004

$850,000

2005

$950,000

2006

$1,000,000

After 2006

tied to inflation

Excluding Part of the Estate After Death with a Conservation Easement

Conservation easements allow the landowner to give up the right to develop the property in perpetuity. Selling or donating an owner's development rights reduces the fair market value of the land, which reduces the associated estate taxes. In the past, this had to be done before the owner died and the property was passed on to the heirs. Therefore, it did not provide a method for heirs to reduce a large estate tax burden after death.

The 1997 Taxpayer Relief Act allows an executor of an estate to exclude up to 40 percent of the value of the land in a qualified conservation easement. To qualify, the land must be located within a 25-mile radius of a metropolitan area, national park, or wilderness area or within 10 miles of an urban national forest. This major change, subject to some restrictions, allows heirs with a large estate tax to put the land into an easement, eliminate future land development, and significantly reduce the land value and estate tax. Almost the entire state of Maryland qualifies for this special exclusion. This is due largely to the Baltimore-Washington metropolitan area, the lengthy C&O Canal that runs the length of the Potomac River, and the Catoctin National Park north of Frederick. This provided an excellent opportunity for Maryland forest owners who have seen the value of their forest properties increase rapidly with development pressures.

Contact the Maryland Environmental Trust concerning a donation of a conservation easement and the Maryland Agricultural Land Preservation Foundation concerning a sale. Sources of other information:

“Legal Aspects of Owning and Managing Woodland,” Thom J. McEvoy. Island Press,1998.

“Preserving Family Lands, Book I” and “Preserving Family Lands, Book II: More Planning Strategies for the Future,” 1997 & 1998. Stephen J. Small. Landowner Planning Center, Boston, MA.

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