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other basis in the timber. Your cost does not in- clude the cost of land or any amounts recovera- ble through depreciation. Depletion takes place when you cut stand- ing timber. You can figure your depletion de- duction when the quantity of cut timber is first accurately measured in the process of exploita- tion. Figuring cost depletion. To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit. Timber units. When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. You measure the timber using board feet, log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate. The term “timber property” means your eco- nomic interest in standing timber in each tract or block representing a separate timber account. Depletion unit. You figure your depletion unit each year by taking the following steps. 1. Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property, earlier. 2. Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital. 3. Figure the number of timber units to take into account by adding the number of tim- ber units acquired during the year to the number of timber units on hand in the ac- count at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account. 4. Divide the result of (2) by the result of (3). This is your depletion unit. Example. You bought a timber tract for $160,000 and the land was worth as much as the timber. Your basis for the timber is $80,000. Based on an estimated 1 million board feet (1,000 MBF) of standing timber, you figure your depletion unit to be $80 per MBF ($80,000 ÷ 1,000). If you cut 500 MBF of timber, your de- pletion allowance would be $40,000 (500 MBF × $80). When to claim depletion. Claim your deple- tion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Include allowable depletion for timber products not sold during the tax year the timber is cut as a cost item in the closing inventory of timber products for the year. The inventory is your ba- sis for determining gain or loss in the tax year you sell the timber products. Example. The facts are the same as in the previous example, except that you sold only half of the timber products in the cutting year. You would deduct $20,000 of the $40,000 de- pletion that year. You would add the remaining $20,000 depletion to your closing inventory of timber products. Electing to treat the cutting of timber as a sale or exchange. You can elect, under cer- tain circumstances, to treat the cutting of timber held for more than 1 year as a sale or ex- change. You must make the election on your in- come tax return for the tax year to which it ap- plies. If you make this election, subtract the adjusted basis for depletion from the FMV of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. You generally report the gain as long-term capital gain. The FMV then becomes your basis for figuring your ordinary gain or loss on the sale or other disposition of the products cut from the timber. For more information, see Timber in chapter 2 of Pub. 544. You may revoke an election to treat the cut- ting of timber as a sale or exchange without the IRS's consent. The prior election (and revoca- tion) is disregarded for purposes of making a subsequent election. See Form T (Timber) for more information. Form T (Timber). Complete and attach Form T (Timber) to your income tax return if you claim a deduction for timber depletion, choose to treat the cutting of timber as a sale or exchange, or make an outright sale of timber. 10. Business Bad Debts Introduction You have a bad debt if you cannot collect money owed to you. A bad debt is either a busi- ness bad debt or a nonbusiness bad debt. This chapter discusses only business bad debts. Generally, a business bad debt is one that comes from operating your trade or business. You can deduct business bad debts on Sched- ule C (Form 1040) or your applicable business income tax return. All other bad debts are nonbusiness bad debts and are deductible only as short-term capital losses. For more information on nonbus- iness bad debts, see Pub. 550. Topics This chapter discusses: • Definition of business bad debt • When a debt becomes worthless • How to claim a business bad debt • Recovery of a bad debt Useful Items You may want to see: Publication 525 Taxable and Nontaxable Income 536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 556 Examination of Returns, Appeal Rights, and Claims for Refund Form (and Instructions) Schedule C (Form 1040) Profit or Loss From Business 1040X Amended U.S. Individual Income Tax Return 1045 Application for Tentative Refund 1065 U.S. Return of Partnership Income 1065X Amended Return or Administrative Adjustment Request (AAR) 1120S U.S. Income Tax Return for an S Corporation 1120X Amended U.S. Corporation Income Tax Return 1139 Corporation Application for Tentative Refund 3115 Application for Change in Accounting Method See chapter 13 for information about getting publications and forms. Definition of Business Bad Debt A business bad debt is a loss from the worth- lessness of a debt that was either: • Created or acquired in your trade or busi- ness, or • Closely related to your trade or business when it became partly or totally worthless. A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. Bad debts of a corpo- ration (other than an S corporation) are always business bad debts. Credit sales. Business bad debts are mainly the result of credit sales to customers. Goods that have been sold, but not yet paid for, and services that have been performed, but not yet paid for, are recorded in your books as either accounts receivable or notes receivable. After a reasonable period of time, if you have tried to collect the amount due, but are unable to do so, the uncollectible part becomes a business bad debt. Accounts or notes receivable valued at FMV when received are deductible only at that value, even though the FMV may be less than the face value. If you purchased an account receivable for less than its face value, and the receivable 525 536 544 550 556 Schedule C (Form 1040) 1040X 1045 1065 1065X 1120S 1120X 1139 3115 Page 40 Chapter 10 Business Bad Debts