Rev. Rul. 74-24

Advice has been requested whether the gain recognized from the cutting of timber under the circumstances described below is to be reported as taxable income in the year recognized.

The taxpayer, a nonexempt cooperative within the meaning of section 1381(a) of the Internal Revenue Code of 1954, is engaged in the manufacture and sale of wood products. It owns standing timber that serves as a source of raw materials, and has properly elected the provisions of section 631(a) of the Code to treat the cutting of such timber as a sale or exchange of the timber. The taxpayer is a cooperative of the type described in Revenue Ruling 71-439, 1971-2 C.B. 321. The cooperative described in Revenue Ruling 71-439, however, was composed solely of member workers. The taxpayer is composed of 100 member workers and 15 nonmember workers.

Revenue Ruling 71-439 holds that the gain from the cutting of timber, which the taxpayer recognizes pursuant to the "section 631(a) election," represents the unrealized appreciation in value of timber cut during the year which, in the absence of an election under section 631(a) of the Code, would have been reflected in the taxpayer's ordinary income from the sale of its products and would have been included in amounts available for distribution as a patronage dividend. The "section 631(a) election" permits an early recognition at capital gains rates of an amount that ultimately may or may not be realized by the taxpayer when the finished products are sold.

Under the facts of Rev. Rul. 71-439, the actual realization of the appreciation in the value of the standing timber (when the finished products are sold) is brought about through the cooperative efforts of the members of the cooperative. The Revenue Ruling concludes that the gain recognized by a nonexempt cooperative association pursuant to an election under section 631(a) of the Code is income from a patronage source.

Similarly, in the instant case, the gain recognized by the taxpayer, pursuant to the election under section 631(a) of the Code, is income from a patronage source, in the year the gain is so recognized, to the extent it is attributable to the efforts of member workers and will qualify as a patronage dividend within the meaning of section 1388 of the Code. That portion of the gain attributable to the efforts of the nonmember workers, however, is not patronage sourced and cannot be distributed as part of a qualified patronage dividend within the meaning of section 1388 of the Code. Thus, since the taxpayer employs workers who are not members of the cooperative the recognized gain must be allocated between member workers and nonmember workers to determine the amount of patronage sourced income allocable to the "section 631(a) election."

Rev. Rul. 71-439 is hereby amplified.