One of the most important and significant costs for a Christmas tree grower is their inventory of trees. Each spring, a Christmas tree grower spends a great amount of time, money, and energy to plant seedlings in preparation for future harvests. This inventory is the most important “asset” a tree grower has, and it is important that a grower keeps an accurate count and valuation of their inventory.
Importance of an Accurate Christmas Tree Inventory
An accurate Christmas tree count is extremely important for a number of reasons. First, it helps a grower determine how many trees to sell. With many farms reporting double-digit sales increases in recent years that are expected to continue, many growers are concerned about selling too many trees and having a shortage in future years. Keeping an accurate record of Christmas tree inventory by height will help a grower plan for future sales.
Second, this count will also help determine how many trees a grower needs to plant each spring. Once a grower has an idea of the demand that needs to be met, they can calculate how many trees are needed to meet that demand.
Finally, and most important for tax purposes, an accurate inventory count is important for computing Cost of Goods Sold and will allow for the maximum deduction permissible on the tax return.
Cost of Goods Sold
Cost of Goods Sold includes amounts spent for purchases, labor, and other miscellaneous costs. Purchases include the cost of seedlings planted.
Cost of Labor includes any amounts paid to employees or other hired help to plant seedlings. This labor cost should be kept separate from all other labor costs, such as summer help, harvesting labor, and shearing labor. Planting labor must be capitalized and included in inventory, while other labor costs are currently deductible.
Other Costs includes any other supplies that are used in planting seedlings, such as fertilizer, root dip, and anti-desiccant sprays.
Taking an Inventory Count
The inventory of trees on a farm only needs to be counted once per year. The best time would be right after the Christmas season, so that the count is as close as possible to the beginning of the year. However, other times of the year are permissible as long as the timing is consistent from year to year. An inventory count is required for tax purposes; however, additional benefits of an inventory count include knowing exactly how many trees are on the farm, their height, and their condition.
Inventory Methods
The inventory value of the trees should be held at cost, meaning the actual amounts spent to plant the trees, and not adjusted for market value. Also, in order to avoid specifically identifying each tree that was sold and its associated cost, the IRS generally permits a few different methods to assume the flow of trees sold. The three main methods are:
- First-In, First-Out (FIFO)
- Last-In, First-Out (LIFO)
- Average Cost.
An example will help illustrate the three methods:
Jim is a new Christmas tree grower and began planting seedlings in 2013. He plants a new, quick-growing species that reaches salable height in only 5 years. His first harvest is in 2017 and his inventory count at the end of 2017 is 3,000 trees (assume all 4,000 trees planted survived until 2017). How much is his 2017 Cost of Goods (Trees) Sold?
FIFO & LIFO
As seen in the example above, the FIFO inventory method provides the greatest deduction for Jim’s Cost of Goods Sold. This is because his early years of seedling purchases cost more per tree since he wasn’t purchasing large quantities yet. Frequently, LIFO provides the greatest deduction since costs typically increase each year, as the most recent costs are being deducted with LIFO. However, if LIFO is used, just be aware that the method has some additional complications that are outside the scope of this article.
Average Cost
Average Cost is a simple method that provides a deduction amount between FIFO and LIFO. This will always be the case as it is an average of all costs spent planting trees. Although the largest deduction will not be attained using the average cost method, it should be considered if capital gains on sales of Christmas trees under IRC §631 are claimed on the tax return. IRC §631 requires that a depletion deduction is taken on Form T (Timber). Depletion is similar to Cost of Goods Sold and is calculated the same way as Average Cost, which will simplify recordkeeping if the Average Cost method is used.
Conclusion
There are many other nuances to inventory accounting that are complicated and were not included in this post. Not all of the inventory methods mentioned above may be available to you. To make sure you are treating your inventory costs correctly, you should consult with your CPA or other qualified tax professional. Each tax situation is different and recommendations on what is best for each individual can vary. If you have any questions or suggestions for future posts, feel free to reach out!
