The major objectives of this study were to find out the mechanism behind the sapstaining fungal hyphae penetration into wood elements using electron microscope and to evaluate the exact role of phenolic compounds existing in wood vinegar towards the sapstaining fungal growth inhibition. To formulate the new environmental friendly wood preservative, we neutralized (to pH 7) wood vinegar with NaOH and hot water extracts of Pinus densiflora and Quercus serrata saw dusts were used in the media instead of sterilized distilled water to enhance the fungal growth inhibition property of neutralized wood vinegar. The initial calibration of wood extract was done by calculating the specific gravity, tar calculation and total organic content. GC-MS analysis was performed to identify the phenolic compounds and other ingredients present in both neutralized wood vinegar and acidic wood vinegar by chloroform extraction method. Eleven major compounds were identified in acidic wood vinegar and 7 major compounds in neutralized wood vinegar. Ophiostoma polonicum, O. ips, O. flexuosum, O. narcissi and O. tetropii were the sapstaining fungi used in this study against neutralized wood vinegar, extracts of Pinus densiflora and Quercus serrata. More than 2.5% neutralized wood vinegar contained agar plates were showed strong antifungal activity against sapstaining fungi. The Scanning Electron Microscopy image of fungal growth on wood samples showed the phenomenon of fungal penetration into wood elements. Pinus densiflora was used as wood element for SEM analysis.