Cost Basis Question

Texas Mineral Rights Yoakum County, TX
1

Members of my family own non-producing minerals in Section 725, Yoakum County. There have been leases at times, but they are not currently leased. We inherited these minerals in the early 80’s, and have recently received offers to sell. Don’t think we are interested in the lowball offers, but the question of establishing a cost basis for minerals inherited decades ago came up. Any thoughts on this, or recommendations for who can help determine a cost basis to see what potential tax exposure might be?

Thanks,

RICK

2

The cost basis is the value at the date of inheritance, less depletion deductions over the years, down to (but not below) zero. If you have the estate documents, there may be an appraisal or a list of assets with values. If the minerals were producing at the date of death, then you could establish an appraisal of the production at that time. Or if there was a lease close to the date of inheritance, consider that bonus (which would be small compared to today’s bonus). If the minerals have never been producing, then the estate value was probably viewed as minimal at date of death.

2 Likes
3

No prior production, no estate appraisal, not leased at the time of inheritance. A few leases over the years but don’t quite see how that translates that effectively to overall value for a sale. Do you mean look at a lease in the eighties and compare it to the most recent one, and use that difference as a percentage that can be applied to assume a cost basis for mineral ownership? What if there are currently no leases or lease offers in the last couple of years? What is the ending value in that case if there is no leasing or drilling now, and no prior production? And if it’s kind of difficult to determine for the owner, how does the IRS question it, or calculate its own valuation, I wonder?

Not trying to avoid reasonable tax in the event of a future sale, but interested in trying to get a ballpark understanding. Are there companies or individual appraisers that can determine current value vs. value in the 80’s in a straightforward, affordable way that the IRS likes?

4

Anyway, thanks for your input, TennisDaze…I appreciate it. I guess if there has never been production, and the value was minimal at the time of inheritance, the since there has still been no production, is the value still minimal? Seems not, as we get offers fairly routinely. I suppose that means that the entire sale would be capital gains, if we were to consider an offer.

My head hurts.

5

In the early-mid 80s I was buying relatively small fractional mineral interests in the Permian (Midland) Basin for $50-100 per net mineral acre. As noted, any depletion taken on production would reduce basis.

6

The Directories tab above has Pecan Tree as an appraiser. They can help with past valuations and current.

If you have offers, be sure and ask the forum about current and pending activity nearby. Offers have a strategy and they plan to make a profit off of their buying, so you want to be informed.

1 Like
7

Thanks, Martha!

8

Thanks for the shout-out, Martha!

(disclaimer: Hi, appraiser/engineer here, but I’m not a tax expert, and please consult your CPA for any tax-specific advice)

Unfortunately, @TennisDaze is right on the money (as per usual :)). Retrospective appraisals establish a higher cost basis than the default “$0” many people start with when they inherit minerals, however you have to establish a market value as of that date. You can’t let the present-day value influence the historical value. It needs to be a conclusion you could have reached as of that historical date, had someone done the proper title research, reservoir analysis, and economic study at the time.

Head’s up for anyone else reading this, there’s incorrect information about how to establish a higher cost basis floating around the internet (shocker, I know). Please be wary of anyone who is interested in selling your minerals and who tells you creative ways to increase your cost basis. They’re just trying to help close a deal. For example, taking today’s sales value and then back-calculating the value on the date you inherited based on inflation, commodity prices, or any other similar benchmark is not an established method for oil and gas historical property values. A good rule of thumb is: was there ANYONE who was remotely interested in paying that price back then? You’re only allowed to step up your cost basis to the market value at the time of inheritance, and oil and gas trapped in the ground is not the same thing as a bar of gold sitting in a dusty closet.

Another rule of thumb I usually use is 2010(-ish) is typically the earliest inheritance date I find it worth the time and effort to do a technical analysis to calculate the remaining reserves value at the time of inheritance. Most assets inherited before then would only have value tied to producing wells, and TennisDaze is also correct that establishing the value as of the date of inheritance is just the first step of saving money on capital gains tax. You also have to account for any depletion you’ve already claimed. To put it simply, if it was worth $100,000 in 1980, you claimed $100,000 of depletion of value over the years, then today’s value SHOULD be $0. Any additional dollar you sell it for today would be considered a capital gain beyond what it was worth when you inherited it.

Why 2010? Because 10-15 years of production tends to deplete most of the value for many assets. Also, this is roughly when the shale boom started, and most people looking to save money on capital gains tax are selling assets in a shale play. Which likely means these same assets were worth next to nothing before the shale boom made the acreage valuable. Yes, the oil was technically there before the shale boom, but it wasn’t something the industry knew how to recover and still make money, so it didn’t have value yet. The secret sauce to crack that code wasn’t figured out yet.

I know that was more than you asked, but we get this question a lot and I wanted to answer for others also.

3 Likes
9

Thanks for the detailed info, Tracy! If a sale is ever considered you will certainly be contacted. But I’m still left wondering how the IRS would view a number, any number, presented as a cost basis in a case like I described. If it’s so involved (and probably pretty expensive) to perform that kind of analysis as a seller, what methodology does the IRS use to challenge it? Let’s say a seller is pretty much reconciled to capital gains on the entire sale amount, but figures since it must have been worth something in 1980, so just puts a low WAG number on it. If the IRS objects, what do they base their objection on….or is the burden on the seller to prove that number, whatever it is?

I wouldn’t personally do it that way, but am kinda curious about how this goes, as I’m sure it comes up from often enough.