Mineral Rights and Taxes
If you decide to sell mineral rights, one of the most important questions to consider is the tax impact of selling mineral rights. The tax implications of selling oil and gas mineral rights can be complicated. If you are concerned about the tax impact of selling mineral rights this article will help point you in the right direction.
Important note: This article is written based on selling mineral rights. There are different tax implications for royalty income, leasing mineral rights, right of way payments, etc..
Tax Implications of Selling Mineral Rights
Figuring out whether to sell mineral rights is a difficult question. One of the questions you should ask yourself is about the tax implications of selling mineral rights. A lot of mineral owners do not realize there are major differences between selling mineral rights and collecting royalty income.
If you purchased the mineral rights, your basis will be determined by what you paid for the mineral rights. Whether you should keep the mineral rights or sell them depends upon the price you are being offered and what you paid.
If you inherited your mineral rights, there is a good chance that selling mineral rights is better than collecting royalty income. Why? It all comes down to your basis in inherited mineral rights. Many mineral owners believe that they will owe taxes on the entire amount of the sale. That is not correct!
Let’s look at an example that will help you understand the tax implications of selling inherited mineral rights vs collecting royalty income.
Let’s assume a $100,000 sales price, inheritance in 2003 and sale in 2018. Due to your basis in 2003 and the long term capital gains tax of 20%, you would only owe taxes of $6,823.61 on a sale of $100,000. This means you get to keep $93,176.39 of the $100,000 sales price! Note: See the example further below for how this math works.
Now, let’s assume that you keep the inherited mineral rights. The tax implications of keeping inherited mineral rights is drastically different. The taxes on mineral rights royalties are counted as ordinary income. This means that you pay both state and federal taxes as if it were income you got from working a job. Assuming you fall in the 24% tax bracket for federal, and an average state rate of around 4.5%, this means you will pay a 28.5% rate on royalty income.
If you collect $100,000 in royalty income over a few years, you will end up paying approximately $28,500 in taxes. OUCH! If you are in the top tax bracket, you could be paying nearly $40,000 in taxes. The taxes on inherited mineral rights royalties make selling a much more profitable decision that holding on them.
The net result of selling mineral rights for $100,000 vs collecting royalties:
Sell Mineral Rights: $93,176.39 after taxes
Collect Royalties: $71,500 after taxes + it will takes years to collect
How the sale of mineral rights is taxed should be a key point of consideration when figuring out whether to sell. If you inherited mineral rights, it nearly always makes sense to collect the cash now through a sale and avoid paying income tax over time.
How to determine basis when selling mineral rights
It is important to determine your basis when you sell mineral rights. Your tax basis in the mineral rights is the amount of your capital investment in the property. If your tax basis in the mineral rights in $50,000 and you sell for $100,000, you would pay capital gains on $50,000 when you sell. This is assuming you owned the mineral rights for more than 1 year. Most mineral owners think that they will owe tax on 100% of the sales price. This is usually not correct because most mineral owners inherited the mineral rights!
To determine your basis in mineral rights when selling mineral rights, it depends on how you acquired the mineral rights.
Determine your basis in mineral rights – Purchased
If you acquired your mineral rights because you purchased land or a home that included mineral rights, this section is for you. According to the IRS, you will have no cost basis in the mineral rights unless one of the following conditions exist:
- Seller’s cost included a stipulated amount for mineral rights
- Seller’s basis was the result of an estate tax valuation in which minerals and surface were valued separately
- Seller’s cost basis can be properly allocated between surface and minerals because of substantial evidence of value attributable to the minerals at date of acquisition
In most cases if you acquired mineral rights through the purchase of land or a home you will have $0 basis in the mineral rights. An argument could be made for condition 3 above in certain locations. Please see the section below on how to determine the basis of inherited mineral rights.
Keep in mind that if you recognize a basis in the mineral rights, you would be reducing your basis (amount paid) in your home or land. However, the gain you make on the sale of your primary residence gets favorable tax treatment. It might make sense to determine your basis in the mineral rights under condition 3 above and reduce your basis in your primary residence.
Determine your basis in mineral rights – Inherited
Most mineral owners have inherited mineral rights. If you inherited mineral rights, you will get a stepped up basis at the time you inherited the property. This means that your tax basis in the property will be the value when you acquired the mineral rights through inheritance.
The problem that many mineral owners run into is determining the value of inherited mineral rights. It is impossible to know the value of mineral rights when you inherited them unless you immediately sold them. The IRS has not provided any guidance on how to value mineral rights when inherited in their oil and gas handbook.
So how do you determine the basis for mineral rights when inherited for tax purposes? It is our opinion, that the best way to value inherited mineral rights is to look at the inflation adjusted average price of oil in the year acquired vs the year you sold. Head over to InflationData.com and check out their inflation adjusted price of oil table.
Example of how to determine basis of inherited mineral rights
Using the method we recommend to determine basis in mineral rights, you have to work backwards from the sales price. In our example, you inherited the mineral rights in 2003 and then sold the mineral rights in 2018. The sales price for your mineral rights was $100,000. To determine your tax basis on the sale of mineral rights, check out InflationData.com and look up the inflation adjusted price of oil in 2003 and 2018. This would be $38.06 in 2003 and $57.77 in 2018.
Your basis would then be:
$38.06 / $57.77 = 65.88196% basis in the mineral rights
$100,000 Sales Price X 65.8819% = $65,881.96 your basis (you don’t pay tax on this amount)
$100,000 – $65,881.96 = $34,118.04 amount you pay capital gains tax on (assuming you owned for over 1 year)
$34,118.04 X 20% = $6,823.61 tax due assuming the highest possible capital gains tax rate of 20%
In the example above, on a $100,000 sale we would show the basis as $65,881.96. This means you have a capital gain of $34,118.04 to pay taxes on assuming you owned the mineral rights for more than 1 year. Assuming the highest capital gains rate possible, your tax due on a $100,000 sale would be just $6,823.61. This is because you only pay 20% taxes on the $34,118.04 capital gain.
Important Note: It is possible that you inherited mineral rights in a year that had a higher price of oil than the year you sold. This means that your basis would be negative. If you are in this situation, we recommend consulting with a qualified CPA on how to handle the gain/loss from the sale. You may not owe any tax at all.
Important Note: We are looking only at the inflation adjusted price of oil above. An argument could be made that a review of your specific property should be done to determine what % is oil and what % is gas, and then calculate accordingly. You could then look at the inflation adjusted price of natural gas. However, we would make the argument that natural gas prices have historically been more volatile. In addition, the general oil and gas market and mineral buyers risk appetite is heavily focused on oil so we believe oil is a more consistent and accurate measure.
1099 for the sale of mineral rights?
When you sell mineral rights you may be wondering whether you will get a 1099 for the sale of mineral rights. There is no legal requirement for a mineral buyer to provide you with a 1099 for the sale of mineral rights. This is confirmed by TurboTax directly and also confirmed by the IRS rules for issuing 1099’s. The IRS rules for issuing a 1099-MISC do not require sending a 1099 for the sale of mineral rights. In addition, the IRS rules for issuing a 1099-S also do not call for sending a 1099 for the sale of mineral rights.
However, some mineral buyers elect to voluntarily create 1099’s and send them to mineral owners. We would estimate less than 10% of mineral rights sales are reported via 1099. In most cases, it is up to you to report the sale of mineral rights on your taxes.
Reporting the sale of mineral rights for tax purposes
If you sell mineral rights and need to report the gain, you should report the sale on Form 4797 and your Schedule D according to TurboTax. Please consult with a qualified tax professional to verify the proper way to report the sale of mineral rights for tax purposes.
Selling mineral rights in a 1031 Exchange
It is possible to sell mineral right via 1031 exchange. The IRS provides for selling real property via a 1031 exchange with no tax consequences. However, there are very strict rules to completing a 1031 exchange. You must identify a property within 45 days of selling your mineral rights. In addition, you must complete the sale within 180 days of selling mineral rights. There are many other rules regarding 1031 exchanges that would apply as well.
Please note that a 1031 exchange is a complex process. If you sell mineral rights at US Mineral Exchange and you wish to do a 1031 exchange, please notify us prior to listing mineral rights. We will need to verify you have all the necessary steps in place prior to posting the listing. Please consult with a qualified 1031 intermediary or have the correct bank accounts set up to complete a 1031 exchange.
The more information you can provide about your property the better! We can give you a better idea about the value of selling mineral rights if you provide more information. The most important thing we need is for you to answer the questions and provide your state and county.
If you have the required documents to list, providing those is extremely helpful!
Absolutely not! When you inquire at US Mineral Exchange we will not be putting any pressure on you to sell. We will help answer any questions you have whether you are interested in selling or not.
At US Mineral Exchange, we take privacy very seriously. We will NEVER sell your information or use it without your consent. When you send us documentation or tell us about your property, that information does not go outside our company without your consent. Even when you list a property for sale on our website, we strictly control who has access to the information about your listing so that only legitimate buyers will be able to see property details.
Many mineral owners make the mistake of getting an offer and quickly selling. They then accept an offer far below market value because they felt pressure to sell. There is nearly always a better price available.
We have two types of listings available to help you sell mineral rights for the best price:
Auction Listing – Our auction listings are for just 7 to 14 days. If you have an offer in hand you are seriously considering, an auction listing is a quick way to get a better offer and ensure a smooth closing process. Learn more about our auction listings.
Standard Listing – Our standard listings run for 30 days. These listings are ideal if you don’t have an offer in hand or you are not in a rush to sell. Learn more about our standard listings.
The reason that so many mineral owners decide to sell mineral rights at US Mineral Exchange is access to our large network of mineral rights buyers. Our goal is to help you get top dollar for selling mineral rights by getting your property in front of a huge audience of buyers. This allows buyers to compete against one another which ensures you get fair market value for selling mineral rights.
There are absolutely no cost to list your property. When you locate a buyer by listing your property with us, we are paid a commission directly by the buyers closing agent. This means you never have any out of pocket expenses ever. We only get paid if we can get you a better price than the current offer you have in hand.
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