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Selected Income Tax Considerations

Note of Caution: The following discussion summarizes certain, although not all, federal income tax considerations relating to an investment in Pope Resources by U.S. persons. These considerations may vary with the identity and status of the investor. This summary provides only a general discussion and does not represent a complete analysis of all potential tax consequences arising from an investment in Pope Resources (the “Partnership”). This summary is included for general information only. Nothing herein is or should be construed as legal or tax advice to any investor. Accordingly, each person considering an investment in the Partnership should consult his or her own tax adviser in order to understand fully the possible federal income and other tax consequences of such an investment.


Partnership vs. Corporation
Pope Resources is a publicly traded partnership and, as such, differs in several ways from corporations. A partner in a publicly traded partnership (PTP) owns units of the partnership rather than shares of stock and receives cash distributions rather than dividends. The cash distributions are not taxable as long as the partner's tax basis in the partnership exceeds zero.

Generally, a corporation is subject to federal and state income taxes. As a partnership, Pope Resources is not subject to federal income tax on its income and gain, rather each partner is required to report on its federal income tax return its distributive share of all items of Partnership income, gain, loss, deduction and credit for the partner’s taxable year within which the Partnership’s taxable year ends, regardless of whether the Partnership makes any actual distribution of cash or other property to the partner during that year.

While a holder of corporate stock receives a Form 1099 each year detailing required tax data, a unitholder of a partnership receives a tax reporting package including substitute Schedule K-1 and other forms to file with their income tax return. This tax-reporting package shows a partner's allocable share of the partnership's income, gains, losses and deductions.

An investor’s cost basis in a corporate stock is generally the amount paid to acquire the stock. An investor’s cost basis in a partnership interest, however, does not remain at a fixed amount. Generally, the initial basis of a partner for its interest in the Partnership is equal to the amount that the partner paid to acquire its Partnership units. A partner’s basis will thereafter be increased by the partner’s distributive share of Partnership income and gain and its allocable share of certain Partnership non-recourse liabilities, and reduced by (1) the partner’s distributive share of Partnership losses; (2) Partnership distributions made to the partner; (3) decreases in the share of Partnership liabilities previously included in the partner’s basis; and (4) the partner’s distributive share of certain other expenditures (i.e., nondeductible Partnership expenditures not properly chargeable to the capital account).

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Limits on Loss Deductions
Pope Resources is subject to the passive activity rules for PTP’s. The rules are to be applied separately for distributive share items attributable to each PTP. Accordingly, the passive income from the Partnership (if any) for a given year may not be used to offset passive losses resulting from an investment in any other PTP or any other passive activity. Similarly, losses from the Partnership, if any, may not be used to offset passive income resulting from an investment in any other passive activity.

Subject to aforementioned passive loss rules for PTP’s, a partner may deduct its distributive share of the Partnership’s losses (ordinary or capital) only to the extent of its adjusted basis in its interest in the Partnership at the end of the Partnership’s taxable year and even then, if applicable, only to the extent the partner is “at risk” at the close of the taxable year. The ability of a partner to use its distributive share of the Partnership losses may be further limited by the passive activity loss rules and capital loss limitation rules. These limitations should be discussed with your tax adviser to determine if they apply.

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Cash Distributions and Sales of Partnership Interests
Generally, a partner recognizes no gain or loss on distributions of cash from the Partnership. If a partner were to sell its interest in the Partnership, any gain on the sale is generally treated as capital gain (assuming the interest was held as a capital asset).

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Section 754 Election
The Partnership has filed an election under Code Section 754 to adjust the basis of Partnership property in connection with certain distributions to a partner, or upon transfer of an interest in the Partnership by sale or exchange, or on the death of a partner. Where an election under Code Section 754 has been made and a transferee partner’s basis in its interest is either greater or less than its proportionate share of the Partnership’s basis in its assets, the Partnership’s basis in its assets must be increased or decreased (as the case may be) by such difference. Such increase or decrease will constitute an adjustment to the basis of the Partnership’s property with respect to the transferee partner only.

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Taxation of Timber Sales
A core business of the Partnership is the sale of timber or timber products located on its properties. These sales may occur in one of two ways: (i) sales of harvested timber, in which the Partnership hires a logger to log specific trees or tracts and then sells the resulting forest products, or (ii) sales of “cutting rights”, whereby the buyers purchase only the standing timber that they harvest and pay for it as it is cut. The federal income taxation of these alternative forms of timber sales is summarized below.

The Partnership has made an election under Code Section 631(a) to treat the cutting of timber owned for more than one year as a sale of the timber cut during the year. Income from such a deemed sale, measured by the excess of (a) the fair market value of the timber as of the first day of the taxable year in which it is cut over (b) the depletion basis of that timber, generally is treated as gain derived from property used in a trade or business, the net income from which is treated as long-term capital gain under Code Section 1231 and, to the extent allocable to individual Partners, taxed at reduced capital gains tax rates. The fair market value of the cut timber is then treated as the cost basis of the cut timber for purposes of calculating the ordinary income or loss recognized by the taxpayer upon the sale of the resulting forest products. The potential application of the principles of Code Section 631(a) are illustrated by the example found in this website labeled “Tax Yield Worksheet”.

If, instead of engaging in timber harvesting activities, the Partnership sells cutting rights, then the sales will be structured to fall within Code Section 631(b), under which income from the disposal of timber held by an owner for more than one year pursuant to a contract by which the owner retains an "economic interest" in the timber is treated as capital gain. The central requirement of a retained economic interest generally is satisfied if the contract specifies that the buyer acquires only the timber that it cuts. Under applicable Treasury Regulations, any net income from the sale of cutting rights qualifying under Code Section 631(b) will be treated as gain derived from property used in a trade or business, the net income from which is treated as long-term capital gain under Code Section 1231.

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Unrelated Business Taxable Income
Under Code Section 511, a retirement plan or other entity otherwise exempt from federal income tax nonetheless may be subject to tax on its “unrelated business taxable income” (UBTI) which, generally speaking is the net income it derives from the conduct of any trade or business not substantially related to its exempt.

UBTI does not, as a general matter, include certain types of investment income – such as dividends, interest and royalties – or gain from the sale of property other than inventory and property held for sale to customers in the ordinary course of business.

Notwithstanding this general exclusion, applicable Treasury Regulations provide that gain or loss recognized upon the sale of timber with respect to which a Section 631(a) election has been made is included in the calculation of unrelated business taxable income. On the other hand, the IRS has taken the position that capital gain recognized from disposal of timber pursuant to the cutting rights contracts under Code Section 631(b) is excluded from unrelated business taxable income, regardless of whether the timber would otherwise be considered as held primarily for sale to customers in the ordinary course of trade or business. Since the Partnership routinely engages in timber harvesting activities with respect to which an election under Code Section 631(a) has been made, a tax-exempt investor should assume that holding an interest in the Partnership would result in allocations to that investor of UBTI.

Because certain income derived by the Partnership and allocated to a tax-exempt Partner is expected to constitute unrelated business taxable income to that partner, potential investors that are tax-exempt entities are strongly urged to consult with their tax advisors prior to investing in the Partnership.

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State And Local Taxes
Investing in the Partnership may subject the partners to certain state and local income or excise taxes in states in which the Partnership may be deemed to be doing business or own property.

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Corporate Headquarters: 19950 7th Avenue NE, Suite 200, Poulsbo, WA 98370     phone (360) 697-6626     fax (360) 697-1156

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