Taxation of Mineral Rights Law
Leverage Profit to Reduce Tax Burden
When you make a profit from mineral rights and royalties, it falls under your personal income tax. As a result, you won’t earn any deductions when your minerals are extracted. Your taxable income is based on profit rather than gross income; you’ll be able to subtract your related expenses prior to calculating your income tax.
Current Production Affects your Severance Tax
A severance tax is administered by most states based on one of two characteristics of mineral rights production: volume or value. As an owner of mineral rights, you must pay a pro rata share of the severance tax. If you’re currently earning royalties, you’ll find these deductions itemized on your monthly royalty revenue statements.
County (Ad Valorem) Royalty Tax
Ad Valorem Tax, which is Latin for “according to value,” are taxes which are levied at the County level. In most states, a county ad valorem tax is payable while minerals are currently in production. This taxation of mineral rights is collected once each year.
State & Federal Royalty Tax
As we discussed earlier, revenue earned from mineral rights and royalties are considered by the federal government to be ordinary income. The same is true for most states. Ferrari Energy takes pride in being one of the top oil companies in Colorado, and strive to help landowners understand taxation of mineral rights in the states of Colorado, Oklahoma, Texas and Wyoming.
Save Money by Deducting Costs
Not all sale proceeds are taxable. Since only the gains are taxed, you can deduct owner costs before the taxation of mineral rights. The IRS only requires you to declare profit, so as a result, you can deduct your severance taxes as well as other expenses, such as processing fees, transportation costs and other expenses incurred through mineral rights ownership.
Claim additional write-offs each year!
According to the IRS,
“The depletion deduction allows an owner or operator to account for the reduction of a product’s reserves. There are two ways of figuring depletion: cost depletion and percentage depletion”
If you qualify for a depletion allowance, you can reduce your overall taxation of mineral rights and royalties. Typically, the IRS allows landowners to deduct up to 15% of their mineral rights income from interest. You generally must choose the method that provides you with the larger deduction (cost vs. percentage).
Capital Gains Tax
Long-term Capital Gains
May be 50% less than ordinary tax rate
If you’ve owned mineral rights and royalties for more than 1 year, then you qualify for what’s known as ‘long-term capital gain treatment.’ Taxation of mineral rights considered to be long-term capital gains may have a tax rate of 50%+ less than ordinary income tax. This means your federal tax liability may more than half what it would be otherwise.
A mineral rights owner’s cost basis is generally equal to the estimated fair market value of the mineral rights at the time of inheritance. Your tax liability is then reduced by a certain percentage of sale proceeds. For example, if the cost basis represents 20% of the your total sale proceeds, your tax burden would then be further reduced by 20%.
1031 Exchange for Mineral Rights
Defer paying capital gains taxes!
This is done when you exchange your mineral rights on land with similar properties, such as other mineral interests or investment properties.
Developing the Land Yourself
Claim Losses From Working!
Become an active partner to write of more expenses and possibly claim losses from working interest against other income.
Taxation of Mineral Rights Resources
- Mineral Rights 101 – Discover critical 2017 mineral rights from Adam Ferrari, an industry-leader and experienced petroleum engineer, via Mineral Rights 101.
- IRS IRM 4.41.1 – Consult the Internal Revenue Service’s Internal Revenue Manual (IRM) 4.41.1, Oil and Gas Industry, Oil and Gas Handbook, for details on taxation of mineral rights in the United States.
- TaxAct: Royalties – General Information – Find general information about how to report royalty income during tax-season using the TaxAct tax filling program.
- Intuit: Mineral Rights Lease Agreement – Read-up on Intuit TurboTax-specific information regarding filing a 1099-MISC for executing a mineral rights lease agreement.
Need More Assistance Managing Your Mineral Rights?
- Request a consultation for your oil and gas mineral rights for sale;
- Learn more about mineral royalties in our Mineral Rights 101 guide;
- Discover our expert tips for how to sell your mineral rights;
- Read our comprehensive guide for how to value mineral rights.
- Gather information about your mineral rights ownership.