The U.S. home building sector is starting to show improvement that offers a promise of better prices and demand for timberland owners.

The U.S. Commerce Department reports that housing starts in August hit an annualized rate of 1,126,000 units, the fifth consecutive month that starts have been above the one million level and an increase of almost 17 percent over the same period in 2014.

Permits for new home construction, an indicator of future building, were even stronger in August, hitting 1,170,000 units, up almost 4 percent from July and more than 12 percent from the same month in 2014, the Commerce Department reported.

The increase in home building is expected to be reflected in increased demand and higher prices for lumber and sawtimber, both of which have been depressed due to weakness residential construction.

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Prices received by tree growers eased modestly in the second quarter of 2015 from first quarter as home construction continued to make a recovery, the head of one of the nation’s largest forestry management firms reports.

Marshall Thomas, president of F&W Forestry Services that operates across the southern pine belt as well as the central and northeast forested regions of the U.S., said the pick-up in home construction and other demand factors were not enough to offset the seasonal decline in timber prices but the wet weather conditions forecasted for this fall and winter could result in a strong run-up in prices.

“Housing starts continued their slow rise, reaching an annualized average of 1.027 million units through May 2015. Of course, this is a long way from strong demand but compared to 500,000 starts a few years ago it looks pretty good.  Remember, the rule of thumb is that we don’t feel demand pressure on timber prices until we hit about 1.3 million starts,” Thomas writes in the summer edition of his firm’s newsletter, The F&W Forestry Report.

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Last year, former House Ways and Means Committee Chairman Dave Camp (R-MI) proposed to repeal four critical timberland tax provisions in the U.S. Tax Code.  His draft legislation, which was formally introduced in December 2014 as H.R. 1, would be catastrophic for small forest landowners, a group already reeling from the impact of the worst recession in the forestry world since the 1980’s.

These provisions identified for removal include:
* The long-term capital gains treatment of timber revenue. (IRC 1231(b)(2))
* The deductibility of timber growing expenses in the year they are incurred, rather than capitalizing these costs. (IRC Sections 162 and 263A(c)(5))
* The deductibility of up to $10,000 of reforestation expenses as these expenses are incurred and the allowable amortization of remaining reforestation expenses over a seven-year period. (IRC Section 194)
* Treatment of timberland and standing timber as real property for purposes of the real estate investment trust (REIT) rules. (IRC Section 856) (not considered in this article)

In order to quantify the impact of these changes on a small forest landowner, we have taken the forecasted cash flows from an actual 631 acre timberland property in Georgia, which we renamed the “Sample Tract” to protect the privacy of the landowner.

In terms of cash flow from the property, the average annual cash flow per acre from all sources, after taxes, under the current tax provision is $53.37.  Taking away capital gains reduces this to $37.96, and taking away the deduction and amortization provisions reduces this further to $35.46.

To put it into terms for the non-financial among us, let’s take a look at the impact on a timber sale for a typical landowner who has little cost basis in the property.  If they receive $2,000 per acre for a final timber sale of a 30 year old pine plantation, the current net, after sale expenses, is about $1,200 ($2,000 less sales cost of $100 less capital gains tax of about $450 less $250 reforestation cost).  After all expenses, the landowner retains only a little more than half of the gross receipts.

If the law changes, then the landowners net is reduced to $825 ($2,000 less sales cost of $100 less ordinary tax of about $825 less $250 reforestation cost)—substantially less than half of the gross receipts for the sale—and almost $400 per acre less than they would receive currently.

These are fatal numbers for Southern timberland owners, who are now selling at some of the lowest real timber prices in the last 60 years.

Most small landowners have their property because they inherited it from farming parents, as a recreational property, as a hedge against inflation, as a savings account for college, or some combination of all of these and many other reasons.  Because of these and other diverse reasons for ownership, and the different objectives of each owner, we have a very diverse forest landscape across the South—a wonderful mixture of native forest, plantations, and creeks.

Within these forest types, some landowners thin their trees, some burn to control vegetation and improve wildlife habitat, and some just let the trees grow until they are ready to cut.  Next time you are driving through a rural area of the South take a look at the roadsides and you will see this diverse landscape.

Regardless of objectives and management practices, almost all landowners, especially the smaller ones, need cash flow from time to time to justify the investment they have in the property. Reducing returns and cash flows by almost one-third will force many of these owners to look for other uses for their property or stop planting after harvest to reduce costs.

Alternative uses include agriculture or pasture, both fine uses, but neither of which provide much habitat for the diverse wildlife and plant species found in the Southern forest.  The biggest loser, if these tax proposals are implemented, could be the wildlife and plant species found in the Southern ecosystem.  It has taken us 80 years to recover from the pre-depression period in the South, when most land was in farms or cutover woodlands that were burned annually and grazed as pastureland.  It would be a shame to let a short sighted change in the tax code push us back to those conditions.

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More than 150 forestry organizations, timber industry groups, and private timberland owners have come together to file joint letters with the U.S. House and Senate tax-writing committees urging Congress to retain long existing timber tax provisions of the revenue code, including capital gains on timber sales.

The House Ways and Means Committee and the Senate Finance Committee will play influential roles in writing any new or revised federal tax laws applying to timber sales, forest management expenses, reforestation costs, and related expenses involved in the business of growing trees commercially.

The forestry-generated letters to the Congressional tax leaders urged their respective committees to retain the existing tax law treatment of the timber-growing industry, noting it works for trees, forestland owners, including the 22 million family forest owners across the country, wood products and paper manufacturing, fish and wildlife, and outdoor recreation.

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