One question I receive frequently from Christmas tree growers is how much money can I save by switching to the capital gain method?
This “average grower” analysis was based on a full-time grower selling approximately 5,000 trees per year without any other income. However, there are a wide variety of growers: choose and cut growers, wholesale growers, full-time growers, part-time growers, large growers, and small growers. Because of this variety, I wanted to give a little more guidance about who can save the most using the capital gain method.
Capital Gains Refresher
A Christmas tree must meet four requirements to qualify for capital gain taxation according to IRC § 631. The tree must be: (1) more than six years old, (2) severed from the roots, (3) an evergreen tree, and (4) sold for ornamental purposes.
Most trees sold by a grower will meet these requirements; however, there are a some exceptions, including pre-cut trees purchased from another grower, potted trees, balled-and-burlapped trees, and fast-growing species.
Pre-Cut Trees Purchased from Another Grower
Many choose-and-cut growers just starting out, as well as established growers, often supplement their tree sales using wholesale trees purchased from other growers. These wholesale trees a grower resells generally do not qualify for capital gain treatment (except under special circumstances).
Therefore, the higher the percentage of sales from trees a grower raises himself, the greater his tax savings will be under the capital gain method.
How the Capital Gain Method Saves Taxes
The tax savings that result from the capital gain method are due to: (1) a lower tax rate on capital gains (as compared to ordinary income) and (2) as no self-employment tax on capital gains. If a grower has other income, this will affect the tax savings by changing the grower’s tax bracket or changing the amount of self-employment tax owed.
If a grower has other earned income, such as wages from another job or other self-employment income, this other income may affect the tax savings, as social security tax is no longer assessed once an individual reaches $147,000 (for 2022) in earned income.
Therefore, a grower who does not have other earned income over $147,000 will maximize tax savings by using the capital gain method.
Business Entities
The business entity may also affect the tax savings calculation. A C corporation generally does not benefit from capital gains. Based on my experience, very few Christmas tree farms are likely taxed as C corporations. Sole proprietorships, partnership, and S corporation taxation are more popular choices.
If a grower operates his Christmas tree farm as a C corporation, the capital gain method will likely not be advantageous and he should consider converting his C corporation to a different entity type.
Many Christmas tree growers operate through sole proprietorships or single member LLCs. These operations are reported on an individual’s income tax return and are fairly straightforward.
Multimember LLCs and S corporations must file a separate tax return for the entity. The tax savings will be based on the tax situation of each individual owner because their share of income and loss flows through to the individual owner and is taxed on their personal tax return.
Summary
Christmas tree growers who sell mostly their own trees, do not have other earned income over $147,000, and are not C corporations will likely save the most taxes under the capital gain method.
However, in my experience, most growers will save at least a few hundred dollars, if not a few thousand dollars, in taxes by utilizing the capital gain method, even if they don’t meet all of the above requirements to maximize tax savings.
If you are considering switching to the capital gain method, make sure you know how to convert to the capital gain method properly. Also, reach out to me if you’d like help!
