Why stepped-up basis is important for maintaining family forests

Sustainable forestry in the United States is dependent on private forests, mostly in small holdings owned by families and individuals, commonly called family forests.

Nearly 60 percent of America’s forestland is in private ownership and nearly two-thirds of that is in family forests, mostly in small holdings. At 272 million acres, these family forests are the nation’s largest forest ownership group, owning even more forestland than the federal, state and local governments combined. There are roughly 10 million family forest owners. 

Many of these holdings are financial enterprises, producing income to pay for the capital and the expenses associated with owning land and timber, like property taxes and reforestation. Forestry has always presented temporal problems for timber growers; unlike almost all other investments (yes, many forest owners consider money used to plant trees and then manage them to be an investment), cash flows occur at the end of a long timber rotation or growth cycle, decades from when the large initial investment is made to put seedlings into the ground. Federal tax laws have long recognized this peculiarity of long investment period and accommodated it in terms of fairness in taxing timber income.

Recently President Biden has proposed the elimination of stepped-up basis when capital assets are inherited. While this tax provision applies to most capital assets, its impact is pronounced for heirs of capital-intensive enterprises, with family farms being an obvious one. Intergenerational transfers of inherited family farms would be so egregiously affected that the president has promised to exempt them from the elimination. Timber and family forests also need the same exemption. 

Following the death of the owner, stepped-up basis allows for forestland and timber to be valued at current market value, with that value being the new owner’s basis in them. The new owner will calculate any future capital gain using that stepped-up basis. Plus, no capital gains tax is due on the unrealized capital gain that would have resulted from the transfer. For example, if the original owner paid $500,000 for forestland in the past, and at the time of his or her death its value was $2,000,000, then the unrealized capital gain would have been $1,500,000, with the estate owing 20 percent of that, or $300,000 in taxes. 

If timber and forestland investments are not allowed to use a stepped-up basis, and tax is due on the gain at the time of transfer, heirs would need to come up with the funds for a hefty tax payment. To make matters worse, Biden plans to raise the top capital gains tax rate from 20 to 39.6 percent. That tax at the time of intergenerational transfer could be devastating. Some of the forestland might need to be sold off, or timber, managed on a sustainable basis, may need to be harvested early, in an unsustainable manner.   

The unintended consequence of timber losing the stepped-up basis would involve a reduction in sustainable forestry on family forests. A forest management plan requires harvesting on a schedule to obtain sustainability, and early harvesting to pay taxes subverts that. Plus, selling off parts of the forest to pay taxes is a bigger subversion, as it leads to forest parcelization (breaking a forest tract into smaller parcels).     

Ownership change and forest parcelization lead to forest fragmentation, where the forest becomes smaller and the resulting fragments don’t support as much wildlife and other biodiversity. Land use change is more likely, often leading to more pressure to develop land, and timber production becomes more difficult and costly. The process leads to a complex and dysfunctional management pattern over the divided forest. 

Private forests provide about 90 percent of the nation’s timber harvest. Family forests account for the bulk of that and are crucial to a sustainable timber supply. Forest industry generally requires forests supplying their mills to manage on a sustainable basis. So, timber harvesting on family forests contributes to a national goal of recognizing wildlife, recreation, aesthetics, water quality and timber as complementary values produced on a sustainable basis. A lot of these families manage their forests under a forest certification program, like the American Tree Farm System, with formal forest sustainability standards. 

Many Americans understand family farms and understand why the intergenerational transfer of family farm ownerships is something taxes shouldn’t make difficult or impossible. Not so apparent are family forests; they are in the “same boat,” floating on land as their capital, and they are subject to the same type of problems that stepped-up basis redresses for family farms. Both family farms and family forests face great danger in terms of long-term survival if stepped-up basis is eliminated as an option to maintain generation-to-generation ownership. 

Thomas J. Straka is a professor emeritus of forestry and environmental conservation at Clemson University in South Carolina.