I own the mineral rights for an area in Colorado where it looks pretty sure they will be drilling multiple horizontal wells within the year. Based on neighboring existing wells and from estimates by the driller it would look like there will be substantial income from the wells soon. From what I read, it is likely that one half of the production will come within the first 3 years. Is there a tax approach to delay the size of the earliest payments, or spread them out, or some other method to put the funds into a tax deferred product or a trust to legally minimize taxes on these early payments?
You would need to speak to a CPA regarding questions like this. A free forum may not be the best place to get accurate information for your state and federal tax questions.
I had thought that everyone on the forum would be working to limit their taxes on royalties. My mistake. I’ll take your advice and seek the help of a professional. Thanks for the tip.
In our experience, and in accordance with the guidance of our CPA-Tax Attorney, only the depletion allowance has been used in preparing the Tax returns and minimizing tax liability. We have mineral interests in TX, OK, NM, and CO.
Are you dead set on keeping the minerals through development?
The way that I understand it, if you’ve owned them longer than a year, you could sell and cap gains would be considered “long term” and end up being ~15-20%, which is a substantially lower tax rate than the rate of the tax bracket I’m assuming your income falls into. Also, as a royalty owner, the operator takes out taxes, but royalty is also taxed as income, so you’re kind of paying taxes twice.
You can sell and 1031 the amount into real property also.
FYI, arguably the most “valuable” your minerals will be to a 3rd party is at the peak of speculation, right before wells are completed.
Not a tax expert just food for thought.
Very interesting! Had not thought of that approach. I’ve owned the mineral rights for nearly 30 years. It has been leased over that time but had to wait a long time before production now seems emminent. I’ll need to look at the numbers and see how long term capital gains might work out to make up for a 3rd party sale. Thanks.
Thanks for the info. I had just discovered the depletion deduction within the past few weeks. Have to admit that it seems like an unnecessary benefit for the oil producers but you take the deductions where they are offered.
Ted: The depletion allowance is no different than equipment depreciation that equipment purchases get (think auto manufactures) or office building owners get when they rent their space or landlords get on their rental houses. In short, the asset is not worth as much tomorrow as it is today, hence the depletion allowance. But your are correct, if the law is in place use it to your advantage. Exact same thing with 1031 exchanges and the many ROTH Ira’s available. There are lots of legal ways to make the proverbial “snowball” bigger.
A comment on the “kind of paying taxes twice”. The operator in OK takes out the state income tax and the severance tax plus the federal taxes unless you tell them otherwise on the federal taxes. They remit them to the proper authorities on your behalf. When you file your taxes, they are accounted for, so no double paying. A mineral owner only pays their share of each tax once. Contact your CPA for tax clarification and direction on the depletion allowance.
You could sell your mineral rights and do a 1031 exchange if you do the timing correctly. Keep in mind that the known reservoirs of today may not be the reservoirs of the future, so you would be giving away any future potential if you sell.