The short answer is: It depends. The slightly longer answer is that it is determined by the classification of your timber holding, the way to sell the timber, and your modified adjusted gross income (MAGI) for the year.
What is the Net Investment Income tax?
NIIT, also known as the Medicare surtax, is an additional tax applicable to high-income individuals, estates, and trusts with significant investment income. More specifically, it is a 3.8% tax on the lesser of: (1) net investment income or (2) the excess of MAGI over a threshold ($250,000 for married filing jointly and $200,000 for single taxpayers). The tax went into effect in 2013.
Generally, net investment income includes: (1) interest, dividends, capital gains, annuities, royalties, and rents not derived in a trade or business; and (2) income from businesses that are passive activities to the taxpayer. Wages, unemployment compensation, operating income from a nonpassive business, Social Security benefits, tax-exempt interest, and self-employment income are not subject to the NIIT.
Timber income and the NIIT
For federal income tax purposes, your timber activity generally can be classified into one of three categories: 1) for investment; 2) material participation in a trade or business; and 3) passive activity where your participation in a trade or business does not rise to the level of material participation. Due to the level of involvement, most non-industrial private forest landowners fall in the investor category. Farmers with occasional timber sales may treat their timber as property held for sale or use in a business. An example of passive activity is the limited partner in a partnership.
For investors, income on the sale of standing timber is a capital gain. Depending on the holding period, it can be long-term or short-term, but it is usually included in the net investment income for NIIT.
If the standing timber is held in a trade or business for more than one year and sold in a lump-sum or under a pay-as-cut contract, the income generally qualifies for the long-term capital gains tax treatment. Income from the sale of cut timber normally is ordinary unless a 631(a) election is in effect. Under the special election, the income from holding the standing timber is treated as a long-term capital gain, while the portion of the income from selling the cut timber is ordinary income.
If you materially participate in a trade or business, your timber income from the business is not subject to the NIIT, even if it is treated as a long-term capital gain. However, it is subject to the NIIT if your timber activity in a trade or business is passive and your MAGI is over the threshold.
Strategies to manage the NIIT for timber owners
If you can substantiate your timber activity as material participation in your timber business, you can enjoy the long-term capital gains tax treatment of your timber income and won’t have to worry about owing the NIIT on it. However, your timber income may push your MAGI over the threshold and trigger the NIIT on non-timber investment income. Therefore, you may want to manage the timing of your other investment income when you expect to have a significant timber income.
For more information about timber taxation, please see https://www.timbertax.org/publications/fs/taxtips/TaxTip2022.pdf
This publication is for informational and educational purposes, but is not intended as financial, tax, or legal advice.Please consult with your tax advisor concerning your particular tax situation.
Li, Yanshu. “Do I need to pay the Net Investment Income Tax on my timber income?” Southern Ag Today 3(10.3). March 8, 2023. Permalink