Minerals and royalties qualify as real estate under the Federal tax code and therefore are acceptable for sale under Rule 1031 which is sometimes referred to as a like-kind exchange. These transactions are exempt from federal income taxes under the IRS code assuming that they are handled correctly. It is necessary that you hire a qualified facilitator to handle the transaction and there are various rules you must follow. Should you desire to pursue a like-kind exchange, start planning early and hire a qualified facilitator who can guide you through the pitfalls involved with the transaction.
What is the tax rate on oil royalties?
From the standpoint of federal income taxes, oil royalties are taxed as ordinary income with a taxable rate of as high as 39.6% (plus a 3.8% Obamacare add on) depending on your taxable income level. If you sell your royalties and have owned them for more than a year the net proceeds are taxed as long-term capital gains which is currently at 20%. If you live in a state which has a state income you must also pay the applicable percentage in state income tax which can be as high as 10% depending on the state you reside in. Many states also charge a severance tax and can be as high as 12.5% of fair market value depending on which state the property is located. Lastly, in many states the county where the property is located charges you with 'ad valorem' or property tax which averages about 5% of fair market value dependent on the county and state that the property is located.
How do I know that I am being paid the correct percentage on my royalty checks?
Oil and gas companies typically hire an Attorney to prepare a division order title opinion once they have determined that a well that they have drilled is a producer. The Attorney starts with the information on the drilling title opinion and orders a supplemental abstract and from those determines the ownership of the various working interest owners, overriding royalty owners, and mineral and royalty owners. This division order title opinion (DOTO) is then the basis for the division orders the owners will receive that, once signed and returned causes the owner to be placed in pay status. So, how do you know that the percentage attributed to you on the division order is correct? In the most simplistic form, if you know the gross acreage in the producing unit or proration unit, your net mineral acreage, and the royalty on your oil and gas lease you can calculate your ownership. Let’s say for instance that the drilling unit is 640 acres, you own 10 mineral acres in the unit, and your lease was for a 3/16ths royalty.
The calculation would be as follows: 10/640 x .1875= .0029296
Should you not know the net and gross acreage and/or royalty percentage on the lease you are subject to, contact the company that forwarded the division order to you and ask them for the background information inherent to the calculation. The last option would be to run the county records in the courthouse yourself to confirm your ownership. This can be done in the County Clerk’s office or Register of Deeds. Though the decimal percentage on the division order is usually correct, mistakes do happen. Once you sign the division order most absolve the payer of any discrepancies so do your research before you send the division order back to the company.