I recently sold a partial interest in an oil lease for a significant sum of money. The sale agreement noted that the value received was $100. However, the bonus payment for the lease was a 3 figure amount. It was an inherited lease. From a layman’s reading of the relevant IRS Rule, it looks like the bonus would be taxed as ordinary income. Is this true - or are there special conditions that apply to the sale of these kinds of disposition.
I’m assuming that any attorney fees or other costs related to the sale will not be deductible from the bonus amount under the new tax law.
You need to discuss with your accountant or one that is knowledgeable for the laws of the state where the
interest is located. That said, it sounds like you sold an asset, and the proceeds of the sale are not considered “bonus”. If you inherited the working interest, there was a value at the time of that inheritance that determines your “basis” and that is deducted from the sales price to determine the “profit”. The time frame from inheritance to sale is important as the profits can be classified as capital gains that are usually taxed at a different rate than ordinary income. The attorney’s fees and other costs associated with the sale should be deductible against the profit as those are considered a cost of the sale. Again, speak with
an accountant to be sure, especially if the amount of the sale was significant.
(1) Did you sign an oil and gas lease for your minerals and receive a bonus for your minerals? Are you the lessor and Company X is the lessee and so you will receive royalties in the event a well is drilled? This would be bonus income to be taxed at ordinary income tax rates. (2) Or did you own a working interest as a lessee in an existing oil and gas lease and someone else owns the minerals? Did you sign a purchase and sale agreement? In that situation, you may be able to treat this income as capital gains. You should consult your CPA about the type of income and deduction of related expenses.
Thank you for your response. I’ve read conflicting opinions about treating the sale as a capital gain or ordinary income. I live in Santa Barbara, California, not exactly oil and gas country, so few CPAs are familiar with these types of sales. The lease was in Glasscock County, Texas. The inheritance, 1967, was closely aligned with the time of the lease purchase, 1966. Because the documentation has been compromised or lost over the years there’s not much information on the cost basis and it would probably not be cost effective to hire a mineral rights appraise to determine the cost of the lease at the time of the inheritance.
Number two is more closely aligned with my situation. I owned a partial working interest with an overriding royalty interest in a lease. The lease(s) were inherited from my father in 1967 so the paper work regarding the original sale is partially incomplete and in those days what has been retained is rudimentary. Over time the existing wells on the lease I sold have greatly reduced production but my share of the total 600 acre lease, 20 acres, was valuable to the entity, a major oil company, who was consolidated the fragmented lease.