Tax implications of potential lease of mineral rights

Hello everyone,

I am a landowner with a potential lease of mineral rights. The potential buyer has offered an upfront payment and then royalties thereafter. Obviously there are many issues to consider but the big one for me right now is the tax implications of this deal. Is it true that I have to pay tax on the initial upfront payment? Does anyone know if there is a way to mitigate that tax liability?


Dear Mr. Evans,

The upfront payment according to the IRS is in the nature of prepaid royalties. Royalty payments at the current time are subject to either cost or percentage depletion. However, this allowance does not apply to bonus payments.

If it were me and the operator was going to use my surface for operations, I would try to shift as much to damage payments as can reasonably be defended in case of challenge. capische?

Having said that, I am not a CPA and clearly cannot dispense advice along these lines. Bonus payments will be treated as ordinary income, subject to I guess averaging. The proper forum for your question would be in the office of a very competent tax guy.


Dear Mr. Evans,

Yes, your bonus consideration, as well as any future royalty payments, are subject to taxation by the federal government. Don’t forget to include them on your tax return or you might get a nasty letter from the IRS.

In Texas, the state government also gets its cut in the form of a severance tax when the commodity leaves the ground, AND, for the capper, your county government will probably assess a property tax against your production income. The oil-and-gas industry is one of the most heavily taxed and regulated businesses in the country.


Philip Wynne