Determining cost basis for inherited mineral rights

I inherited some mineral rights (royalty only) in 2006. At that time (and that is still the case), there is no production on the property.

In 2015, my brothers and I decided to sell a little over half of the rights. There has been disagreement as to the cost basis of the rights for tax purposes. Two accountants came up with a formula based on the oil price in 2006 versus 2015, and since the price was lower in 2015, there was no gain. However, I'm not sure that this is the correct method.

Is there anyone here who faced a similar issue, and how was the cost basis determined in your case (for tax purposes)? Thank you.

If the accountants are claiming to have expertise in valuing mineral rights for tax purposes then I'd go with their valuation method (using oil prices then vs. now). You might want to even get their findings and methodology in writing from them in case the IRS ever asks how you determined that they are worth less now then they were in 2006.

Ideally, you'd want to use sales records of mineral rights in the immediate area back then vs. now to determine any differences in value over that time period. If none are easily obtainable, you could research lease rates back then vs. now and use the difference in bonus amounts to estimate the change in value over the two periods. One acre of unleased mineral rights is roughly estimated to be worth between 2-3 times the current lease bonus per acre being paid in the immediate area. If the area where your minerals are has not been very active then both of the above methods are going to be difficult to apply.

Finding actual or first-hand knowledge of several sales records in the immediate area in 2006 would be the most accurate way to determine their 2006 value of course, but that's easier said than done, however is doable for someone (i.e. a landman) who was familiar with the area back then, and now.

Using oil (or gas if it's more "gas country") prices from 2006 vs. today as your accountants have done, to determine simply whether they are worth more now than they were then is useful if the area hasn't changed much since 2006. For instance, if the area has not seen a change in the level of activity since 2006 then one could logically conclude that the minerals are worth less now then they were then if in fact oil and gas prices are lower now than they were then. This might suffice for tax purposes even though no actual 2006 "value" was determined.

Hope this helps you out!

Frederick M. "Mick" Scott CMM, RPL

The Mineral Hub

Thank you very much, Mick.