Q: A company has asked for
access to shale deposits on our land. Would we be taxed on money we receive
from allowing access?
A: Almost certainly, yes. Royalty, bonus or other income paid to
landowners in exchange for access to resources on their land is generally
categorized as ordinary income. Depending on filing status and total income
amount, taxpayers typically do need to report these earnings to the IRS.
Q: We’ve been asked to
sign a natural resource extraction agreement. How would we report payments from
that lease agreement?
A: Natural resource extraction
agreements involve “delay rental,” “royalty” and “lease bonus” payments.
Landowners who receive these payments are “royalty owners” who typically do not
have a working interest in the extraction operations. This income is reported
on Part I of Schedule E (Form 1040), Supplemental Income and Loss. Landowners
who do have a working interest in the
extraction operations must file using Schedule C (Form 1040), Profit of Loss
Q: If we get a bonus in
addition to lease payments, how would we report that income?
A: Taxpayers who lease their property so a company can extract
natural resources may receive a lease
bonus. The bonus may be paid in a lump sum or over several years. The
company leasing the land should provide you with a Form 1099-MISC,
Miscellaneous Income, noting the amount of bonus payments as “Rents” in Box 1.
Taxpayers usually report lease bonus income as rent on Schedule E.
Q: How would we report
periodic payments for our share of profits from the natural resources?
A: The company may periodically pay you for your share of
profits generated from your property’s natural resources. These “royalty payments” must be based on
natural resource production on a recurring or intermittent basis, according to your
lease terms. The company should give you a Form 1099-MISC, noting the payments
as “Royalties” in Box 2. Most taxpayers report royalty payments they receive as
“royalty income” on Schedule E.
Both rental and royalty income
(or loss) is also calculated on Schedule E, transferred to Form 1040, Line 17,
to be combined with other sources of income.
Q: Do we get tax credit
for the depletion of our resources?
A: Possibly. Depletion is the “using up” of natural
resources through mining, drilling, quarrying of stone or cutting of timber. The
IRS allows a “depletion deduction” so taxpayers who own economic interests in natural
resources can reduce their taxable income and account for the reduction of
on the type of resource, you may have the option to use either “cost” or
“percentage” depletion. If you qualify for both options, use the method that
yields the greater deduction. For federal tax purposes, the percentage
depletion rate varies according to the mineral being produced. Taxpayers claim depletion
and other allowable deductions on the “Expenses” section in Part I of Schedule
E. See IRS Publication 535, Business Expenses, for more information.
Q: If we had a
working interest in the extraction operations, would we get any deductions?
A: Possibly. If you have
working interests in extraction operations, you may be able to offset your
natural resource income by deducting expenses such as overhead, dry holes and
certain legal and administrative fees and county health department water
testing fees. You also may deduct business expenses such as depreciation,
tangible or intangible costs, utilities, as well as car, truck and travel
expenses related to resource extraction. Severance tax and operation expenses must
be detailed on an Authorization for Expenditures (AFE) statement provided by
the exploration company.
Q: Must I
report the free gas the company is offering?
A: It depends. If the company returns natural gas
extracted from your property to you, the value of the gas received is probably
nontaxable. However, free natural gas from the company may be taxable if the gas
you receive is not from your retained ownership interest. Generally, ownership
of raw gas extracted by a leasing company is based on the lease terms and state
Q: Is federal tax withheld
from natural resource income?
A: Typically, no, so you may want to make estimated tax
payments. See Publication 505, Tax Withholding and Estimate Tax, for more
information. Income from leasing mineral property and royalty payments for
extraction of natural resources can be significant, so familiarize yourself
with the tax rules to avoid an unexpected tax bill. See Publication 525,
Taxable and Nontaxable Income, and the Instructions for Form 1040, Schedule E
and Form 1040, Schedule C.
The information for this “Law You Can
Use” column was provided by the Internal Revenue Service (www.irs.gov). It was
prepared by the Ohio State Bar
Association. Articles appearing in this column are intended to provide broad,
general information about the law. Before applying this information to a
specific legal problem, readers are urged to seek advice from an attorney.
Labels: land, natural resource extraction agreement, natural resources, property, shale