Sign up bonus and royalties - Tax Implications

Accounting and Taxes
#1

My parents just signed several gas well leases. Since I do their taxes every year, I have been trying to determine tax handling. According to what I am reading on the internet, a signup bonus and royalties will be taxed as ordinary income and royalties are subject to either cost based depletion or percentage based depletion. I assume since my parents did not get an appraisal on the property including mineral rights, that I will need to use the 15% percentage depletion on the royalties and that percentage depletion does not apply to the signup bonus. Is this correct?

I also read on a different internet site that signup bonuses and royalties can be taxed as a capital gain (i.e. 15%) depending on how long you own the property. This seems too good to be true. Can anyone clarify for me? To further complicate things, one lease that was signed is from inherited mineral rights that was acquired in 1999 (did not include surface property). Is there any special tax handling for it? There was no appraisal at the time of death of the previous owner and up to that point in time, no income had been made from mineral rights.

Is it so complicated that it is time to turn my parents taxes over to a CPA? Would appreciate some advice!

#2

You should get some professional help for your parents if any of the leases result in production. I personally have dozens of wells and manage many dozen more. It is a complicated business as well production royalties can be deemed "passive" income but if the minerals were purchased in some instances major write-offs can be used. Also, all states are different in how production revenue is handled.

#3

Hi, Diane -

I'd suggest you get in touch with the National Association of Royalty Owners (www.naro-us.org) or a group like the Texas Land & Mineral Owners Association (www.tlma.org).

I would imagine groups like this throughly addressed these issues.

Charles

#4

Here's what I can tell you....

Percentage Depletion does NOT apply to the signup bonus.

If you have ongoing production, it is almost always the case that percentage depletion is far more advantageous than any kind of cost based depletion. You can still do an appraisal back to a certain point in time; it is not too late. But it may be of questionable value.

I am not an accountant, but I have discussed all of this with mine. You cannot treat royalties as capital gains no matter how long you have owned the property. He has told me the same is true with regard to bonuses.

There is NO special tax handling for "inherited" mineral rights.

If anyone has any solid evidence to the contrary, I'm all ears. This should not be rocket science, and should be a common issue with almost all royalty owners.

#5