Calculating tax basis of mineral rights inherited in 2007

Good morning: We inherited 14.2 acres of mineral rights in Williams County ND in 2007. We are considering selling and don’t have any idea how to determine the cost basis in order to calculate capital gains tax. If anyone can steer us in the right direction we’d appreciate it. Thanks.

What section, township and range? Production or no production in 2007? Leased or unleased? The location makes a difference.

Thanks for your question.

Township 156 North, Range 95 West of the 5th PM, Section 10; NE 1/4.

We received the first royalty check in March 2008, after inheriting the mineral rights in June 2007. These rights have been in my husband’s family for generations.

The capital gains tax is based upon value as of the date you received them such as date of death. If you don’t have it, then the IRS uses zero and you are taxed at the full purchase price.

Was the land leased in 2007? If you received your first check in March of 2008, then if probably had about five or six months of production on it which would take you backwards to about October or November of 2007. There are two wells in that section. Since it takes about four-five months do drill a well, you need to go back in your family records and see what you received for your lease bonus in about that time frame. It will give you a clue as to the price per acre that you could use to justify your cost basis. There was very active drilling during that time in the sections around you.

It was leased by my mother-in-law in 2004 to Empire Oil Company for 5 years. She received $994.00 The lease expired in April 2009. Now I’m really confused.

We then started receiving checks in March 2008, with the lease still in effect. We still occasionally receive checks for small amounts. As far as I know there is not a lease now.

If the well was in production then the lease did not expire. It moved into its secondary term and is valid as long as there is continuous production on the tract. (not necessarily from the original well). If you are still getting checks from the original well, then that old lease holds you.

If you divide the lease amount by the acres, you get $70/ac. You may be able to increase that slightly if you had a permitted well on the property as of the date of death.

I really appreciate your willingness to explain all this stuff to me. I know I’m probably taking advantage of you.

I don’t even know what “leased” means with regard to mineral rights and royalties. Is there a way to find out if there was a permitted well on the property as of the date of death? We receive our royalties from Hess. Should I contact them?

I kept a copy of the first royalty check which we received after my mother-in-law died in June 2007. The first production month on the check was October 2007.

Leased is pretty much like leasing an apartment. In very simple terms, they have a document that leases your portion of the mineral rights that belong to a section. They have three years (or whatever term is on the lease) in which to drill a well. Then they split the revenue from the payments on the sales of the oil and gas. They keep about 80% and you get 20% (or whatever the rate is in the lease.) They take all of the risk of drilling the well and pay all the costs. You pay nothing and get your royalties. In ND, part of your royalties may have a component taken out called post production costs. These are fairly standard unless you cut a deal not to have them taken out.

There should be two wells. Wallentinson 1003H-1 online as of 10/27/07 but I haven’t found the permit yet.

BLMU X-28AH. The permit for it was 8/17/07 and online 11/28/07

The ID on our check stub is BL-Wallentinson-156-95-0310H-1.

Hess had the other well also. It may have not production after 2015. Do older stubs show it?

No, just the Wallentinson well.

Thanks again for all your help. I’m a little clearer now on the whole mineral rights/royalties thing. We have an offer from an operating company in Williston, ND for our mineral rights. Not sure what we’ll do. Since we probably won’t have much of a basis for tax purposes, we’ll pay thru the nose for capital gains. I guess I need to figure out if it’s worth it. We have received very little in royalties the past few years.

Thanks again.

Bakken is picking back up. If you don’t need to sell, then hang onto it. We have done that and have picked up royalties through increased density drilling over the past few years.

We actually were thinking the same way. That’s probably what we’ll do.

Dear Sher:

I am not a tax attorney but I am considering selling my minerals as well in a 1031 exchange to buy rental property. I would put 100% of my proceeds into the replacement property to defer any capital gains tax. You still need to determine your basis because that will determine the basis in the replacement property, which helps you determine your depreciation rate each year. I don’t plan to ever sell my property to avoid any capital gains. My daughter will get a stepped up basis when I die; she would be able to sell with no capital gains. Of course the laws may change.

You may want to consider asking your own tax advisor about this move. The IRS changed some of its 1031 exchange laws for 2018.

Paula: Thanks for sharing your situation; however, at this juncture in our lives we’re not interested in acquiring any additional property.