Capital gain cost basis on sale of mineral rights royalty

I inherited a non producing mineral rights in year 2000 & in year 2006 I began receiving producing royalties on the mineral rights thru year 2013 when I sold the mineral rights for $151,000. The County tax assessor collector first issued a taxable value in year 2007 for $111,020. & decreased each year to a taxable value of $46,463. in 2013. For capital gains tax what do I use for cost basis on the sale?

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Basis is the amount you paid for it. It should have been valued when probated in 2000. That would be the paid for price. It is also possible it was adjusted down for depletion during you tax years with the production by your tax professional .

Worst case, you will pay 15% of the entire sale price.

See a CPA familiar with oil gas properties. I am not one.

James,

The assessors estimates usually don't have much weight when a cash transaction takes place. Rick is correct, your CPA will want to know the sale price but also be prepared to list any costs of acquisition such as will probate, legal review of the sale document, cost of advisors to set an acceptable price, and any other transaction costs you incurred in getting title and in transferring title. If you "earned" the inheritance as part of an agreement, there may be other acquisition costs incurred. A CPA familiar with Real Estate transactions may be the most helpful to you and that cost may be a transaction cost as well.

I’m not a CPA, but I’ve come across this issue on occasion, so here’s my understanding of what my CPA tells me.

The basis for all of the property you inherited was stepped up at the time of the inheritance, so your basis would be the value of the minerals in 2000 at the time of the inheritance. Since they were not producing, their value (and their basis) was $0. Your adjusted basis would be the cost basis less accumulated depletion from past years (in other words, you “recapture” depletion in the same way you would for depreciation.) In your case, since the basis was $0 to begin with, you wouldn’t adjust your basis down for the accumulated depletion because you’re already at $0.

Of course, there are probably nuances of this that I’m not familiar with, but I believe those are the broad strokes.

Heirs get a "step up" in basis when they inherit capital assets. So the value (if you will) on the date the asset passed to you is the basis you will have for the sale.

This discussion is useful, but it's still not clear how the basis can be documented. Can anyone speak to that?

Basis is determined as of the date you acquired the asset. That is step one. Step two is how you acquired the asset. If you acquired by purchase, then the cost is the basis. If the cost included both the surface and subsurface, then you must allocate the cost between the two estates. That allocation is fact sensituve and depends upon whether you secured the property knowing the mineral rights had value.

Arms length transactions are viewed by the IRS as the best and most correct way of determing the basis. The closing documents would therefore, "document" the basis.

If you acquired by inheritance, then there isn't any "cost" to you on that date. However, the value of the asset as of that date must be determined because the rules state that your basis is established by the value of that date. That is a good thing. You need to secure a "valuation" of the asset as of that date and the IRS has criteria to establish that value. Mineral managers or valuation experts can handle this pretty easily, even going back in time. They prepare a report and thus "document" the basis.

Step three therefore applies only to non-pruchase transactions such as receiving the mineral rights by will or by gift, etc.. those times when an arm's length transaction does not provide you with the raw numbers.

Steven,

Awesome explanation of an variable and subjective concept.
Steven Franckhauser said:

Basis is determined as of the date you acquired the asset. That is step one. Step two is how you acquired the asset. If you acquired by purchase, then the cost is the basis. If the cost included both the surface and subsurface, then you must allocate the cost between the two estates. That allocation is fact sensituve and depends upon whether you secured the property knowing the mineral rights had value.

Arms length transactions are viewed by the IRS as the best and most correct way of determing the basis. The closing documents would therefore, "document" the basis.

If you acquired by inheritance, then there isn't any "cost" to you on that date. However, the value of the asset as of that date must be determined because the rules state that your basis is established by the value of that date. That is a good thing. You need to secure a "valuation" of the asset as of that date and the IRS has criteria to establish that value. Mineral managers or valuation experts can handle this pretty easily, even going back in time. They prepare a report and thus "document" the basis.

Step three therefore applies only to non-pruchase transactions such as receiving the mineral rights by will or by gift, etc.. those times when an arm's length transaction does not provide you with the raw numbers.

Thank you for the kind words Gary.

Steve

Gary L. Hutchinson said:

Steven,

Awesome explanation of an variable and subjective concept.

Gary L Hutchinson

Minerals Management

Steven Franckhauser said:

Basis is determined as of the date you acquired the asset. That is step one. Step two is how you acquired the asset. If you acquired by purchase, then the cost is the basis. If the cost included both the surface and subsurface, then you must allocate the cost between the two estates. That allocation is fact sensituve and depends upon whether you secured the property knowing the mineral rights had value.

Arms length transactions are viewed by the IRS as the best and most correct way of determing the basis. The closing documents would therefore, "document" the basis.

If you acquired by inheritance, then there isn't any "cost" to you on that date. However, the value of the asset as of that date must be determined because the rules state that your basis is established by the value of that date. That is a good thing. You need to secure a "valuation" of the asset as of that date and the IRS has criteria to establish that value. Mineral managers or valuation experts can handle this pretty easily, even going back in time. They prepare a report and thus "document" the basis.

Step three therefore applies only to non-pruchase transactions such as receiving the mineral rights by will or by gift, etc.. those times when an arm's length transaction does not provide you with the raw numbers.

My dad put everything into a family trust. He died in 1994. When mom died in 2004 my sister and I are left. I had an offer to sell some mineral rights that are non-producing in Love County Ok. My sister wanted me to do so and I did. I am attempting to figure out our tax liability. Daddy bought the land in about 1948 and sold the land several years later but kept 1/2 of the mineral rights. I have no idea how to figure a basis for knowing for sure how much gains I have to show. Any ideas.

Jean

Re the case where my parents gifted me and my wife the mineral rights about 10 years before they died. We recently sold these mineral rights and was wondering if there was a basis for this asset or any way to determine a basis. My non oiled accountant said it was Zero. Any comments?

When they gifted them to you, they gifted the basis they acquired them.

So how did your parents obtain them?

It was gifted to my Dad from his mother prior to her death for " $ 10".

It would not allow me to reply below.

Was it "Gifted" or "Sold" for $10? :)
Gifted then again the cash basis was gifted with it.
If actually sold then your basis is $10 and you saved $1.50 by claiming it. If you are in the most common tax bracket.


Realistically it was a gift and the $10 didn't change hands, and you go back another generation. If there was on production on it at the time it would have still been minimal. If you are talking about a small acreage, I would go with your CPAs recommendation of $0. You pay an extra $1.50 to $100 in taxes and how can they come back and say it was worth less? And you don't spend money trying to document the actual value in the 1947. Now if there was production when it was passed in an estate, that might be worth pulling the estate records. The value should have been determined at that time and the basis would have been reset. Also consider depletion (on producing properties) should have been taken on subsequent tax filings which also should lower that basis.
Confirm the above with your CPA, and if you are still not comfortable with his answer get a second opinion from another CPA or tax attorney with your specific data. Just be careful not to spend more in professional fees than you would save in taxes.

Any recommendations on where to find a mineral manager or valuation expert? I currently live in Oregon but all my minerals are in Texas. I am contemplating selling so I want to have all my bases covered.

Non-producing minerals have a value, howbeit often low. Just because the production is zero, does not mean the mineral rights are zero value. They are simply undeveloped. A mineral appraiser can value them. Stay away from engineering values. Sales are key to the value of non-producing minerals.


Don't conflate the assessor's values from the actual estate values. They are totally separate issues.

You probably need the value of the minerals in 1994 at the time of his death, not the 1948 figure. Go see a CPA or tax attorney who is familiar with estate taxes and mineral rights.

I am also writing about establishing a value for inherited oil mineral royalties. My tax adviser suggested -- and I have seen this idea elsewhere -- that we value it based on the price of oil as of the date of inheritance. Any thoughts on this?

Also, I understand the logic of hiring a valuation expert. However, if my guess is the value of my royalties is correct, I could not justify the cost of the expert.