Tax Forms All Mineral Owners Should Know About

When it comes to owning mineral rights, you could stand to make a lot of money if you choose to lease or sell those rights. However, additional income also means additional taxes, and complying with the IRS’ myriad tax forms is nothing short of onerous for most mineral owners. Whether you’re receiving oil and gas royalties or debating selling your mineral rights, here are some of the tax forms you should know about. Please keep in mind that we are not attorneys or CPAs; please consult your own accountant or legal counsel for tax advice. For IRS guidance on the subject, please click here.

Leasing Your Mineral Rights

When you lease your mineral rights, income may come in the form of delay rental, oil and gas royalties, and lease bonuses.

  • Delay rental income – This is income stemming from a common clause found in most lease agreements. Favored by the lessee, this payment essentially removes the lessee’s (driller’s) obligation to start drilling during the primary term of the contract. This means that if you choose to lease your mineral rights, it could be a very long time before you actually see any royalties if the lessee opts not to drill. Delay rental income is generally a small check received periodically throughout the term of the contract. When filling their tax return, lessors should include this income on Schedule E, line 1 of their Form 1040, which is used to report supplemental income.
  • Lease Bonuses – Normally paid at the time of signing or over the life of the lease, lease bonuses constitute additional income to incentivize the lessor to sign the agreement. This income is treated as rental income and should also be reported on the taxpayer’s Schedule E, line 1.
  • Royalty Payments – If the lessee does begin production and extraction begins, the lessor can expect to start receiving oil and gas royalties. These royalties should also be reported on Schedule E, except that these go on line 2.

Other Tax Implications of Leasing

  • Rents and royalties reported on Schedule E are considered ordinary income and are therefore not eligible for favorable treatment as capital gains.
  • The lessee is responsible for providing the lessor with a Form 1099-MISC each year summarizing the rent and royalty payments made. This information should tie to the income reported on the lessor’s schedule E.
  • Per the IRS, net income or loss from royalty and lease payments of natural resources is not considered passive income.
  • You may also be eligible to take a depletion deduction to account for the reduction of reserves. Discuss whether or not you are eligible for the deduction with your CPA and if so, which depletion method (cost or percentage) applies.
  • The above information assumes that you are not an owner-operator in the production process. If you do have a working interest in the process of extraction, your income would be reported on Schedule C and additionally subject to self-employment tax.

Selling Your Mineral Rights

If you sell your mineral rights or oil & gas royalties, the IRS indicates that the sale can be treated one of two ways:

  • Your sell could be treated as the sale of business property which would be reportable as a section 1231 gain or loss reportable on form 4797.
  • Depending on how the property is held, the income or loss from the sale may be reportable as a capital gain or loss on Schedule D.

Make sure you discuss the sale with your attorney or CPA to ensure proper reporting on your tax return.