DEATH & TAXES
Paul D. Spillers
It is often said that “death & taxes” are the only two certainties in life. The purpose of this discussion is to increase awareness of some of the more important “death & tax” issues that confront timberland owners.
When an individual dies all land he owns passes to his heirs (no will) or to his legatees (under a will). The process of passing property from the Decedent to the living is known as a succession proceeding. New owners will be recognized under our law only if there is a succession proceeding filed at the courthouse. The failure to file a succession proceeding can cause many complications, even loss of ownership. Succession proceedings should be filed within nine (9) months after the date of death. The heirs or legatees who file a succession proceeding should ultimately receive a Judgment of Possession from the court recognizing their co-ownership interest. Only then can the heirs and legatees sell, mortgage, lease or donate their interests in the land.
A. Type of Property.
All property in Louisiana is categorized as either community property (purchased during the marriage) or separate property (brought into the marriage, or received by inheritance or donation). Community property is co-owned by the spouses with each owning a ½ interest.
B. Die Without a Will.
If a person dies without a will all of their property is inherited, equally, by their children. This includes all of their separate property, but only the Decedent’s ½ of the community property. The surviving spouse gets a “usufruct” (right to use) over all of the community property. The “usufruct” does not apply to separate property.
C. Die With Will.
Generally, a person is free to leave their property, by valid will, to whomever they choose. However, there are two major limitations on what a person can do with their property in a will:
1) Forced Heirship. A child under the age of 24 or a child, of any age, who has a physical or mental infirmity is a “forced heir” and is legally entitled to a part of the parent’s estate.
2) Marital Portion. A surviving spouse who is “poor” in relation to a “rich” deceased spouse is entitled to a part of the “rich” spouse’s estate.
II. CO-OWNERS OF LAND.
A. General Rules
1) Two or more individuals may co-own land. Co-ownership usually arises when two or more individuals inherit property. Co-ownership also arises when two or more individuals purchase property.
2) Each co-owner has a right to possession of the property. A 1% co-owner has the same right to possession as a 99% co-owner. Do you see a potential conflict?
3) Income and expenses associated with co-owned property are split in proportion to ownership interests. If one co-owner pays more than his proportionate share he has a right to receive reimbursement from the other co-owners.
4) An individual who is a co-owner has a right to sell, mortgage, or donate only his undivided interest in the land. Valuation of undivided interests is uncertain. Sellers usually must accept large discounts to attract buyers.
5) Each co-owner has a right to partition (divide) co-owned property.
B. Partition of Co-Owned Property
1) Each co-owner has a right to partition the property in order to liquidate his interest in co-owned property.
There are two basic types of partitions:
a. Partition in Kind. Each receives a piece of the co-owned property in full ownership. This method is preferred under our law.
b. Partition by Licitation. Each receives a share of the sale proceeds after a sheriff’s sale of the co-owned property. This method is available only if the property can not be partitioned in kind without decreasing the aggregate value of the property.
2) A co-owner who owns less than a 15% interest in property has no right to partition by licitation. A less than 15% co-owner gets only the appraised value of his share. There is no sheriff sale.
C. Sale of Timber
1) Generally, all co-owners must consent to sell timber. One co-owner can “block” the sale.
2) However, co-owners who, in the aggregate, own at least 80% interest may sell timber without the consent of the remaining co-owners. However, the sale proceeds attributable to the non-consenting co-owners must be placed in escrow for the benefit of the non-consenting co-owners.
Co-owners of minerals can lease their interest in the minerals without the consent of other co-owners. Each co-owner is free to negotiate the “best deal” possible with the oil company. Consult with a lawyer before you sign any mineral lease.
Many different taxes are, potentially, applicable to a timberland owner. They include, but are not limited to, income (state and federal), estate, gift, ad valorem (property), severance, etc. The tax that is most common, however, is the federal income tax. The income tax that will be highlighted below.
A. Categories of Land Ownership.
1) Hobby: No profit motive; the only purpose is pleasure.
2) Investment: The primary motive is profit; but no active management by the owner.
3) Business: The primary purpose is profit; plus active management by the owner.
B. The income tax consequences of owning timberland will vary depending upon which of the three ownership “boxes” you fit within. Income from all three categories is usually taxed the same: capital gain, and a maximum tax rate of 15%. The key question usually is whether or not the expenses associated with these ownership categories are deductible.
1) Hobby. Expenses are not deductible.
2) Investment. Expenses are deductible, but with major limitations.
3) Business. Expenses are fully deductible, and with no limitations (the best “box”).
C. Factors Considered by IRS In Determining Whether Timberland Ownership is a Business:
1) Whether the activity is conducted in a business-like manner (plans, records, etc).
2) The expertise of the taxpayer or his (her) advisers.
3) Material participation by owner.
4) The expectation that the assets of the activity will appreciate in value.
5) The previous success of the taxpayer and the conduct of similar activities.
6) The history of income or losses from the activity.
7) The relationship of profits earned to losses incurred.
8) The financial status of the taxpayer.
9) Elements of personal pleasure or recreation in the activity.
D. Deductible Items.
If the ownership is found to be a “business” then the taxpayer may deduct all of the ordinary and necessary expenses associated with owning and managing the timberland. This includes, but is not limited to, interest on debt used to purchase the property; depreciation of equipment, fences, barns, roads, etc.; insurance; property taxes; tree planting costs; herbicide application; consultant fees; business travel, tools, etc.
1) Tax Savings. $3,000.00 of deductions on your timberland will save $1,000.00 in taxes if you are in the 30% tax bracket.
D. Additional Information.
If you would like to obtain additional information regarding timberland taxation go this website: timbertax.org
Good management means planning for the disposition of your property at death and planning to reduce your taxes during life. Being proactive with a business/legal management plan can save you income taxes and reduce stress among your loved ones at your death.