In this episode we focus on a few valuable year-end tax tips specifically tailored for mineral rights owners. The episode covers a wide range of strategies that can help minimize tax liabilities in relation to mineral and royalty ownership so that you can keep more of your hard-earned money.
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Deferring Income to the Next Tax Year
One of the strategies discussed is the concept of deferring income. By deferring lease bonus payments to the next tax year (or across multiple years), mineral rights owners may be able to optimize their tax liability, especially if they are already in a higher marginal tax bracket in the current year due to higher than average income from other sources (job, commission, etc.).
Offsetting Gains
Offsetting gains with losses from investments is another important strategy. This involves selling losing investments to offset gains from the sale of mineral rights. The tax benefits of capital loss harvesting are explained in detail, including the ability to deduct up to $3,000 of excess losses from other income.
Tax Credits and Tax Deductions
The episode also emphasizes the significance of taking advantage of tax deductions available to royalty owners. Mineral rights owners can benefit from deductions such as the depletion deduction, which is a tax benefit specific to royalty owners. The depletion deduction allows owners to recover their cost basis over time as the oil and gas reserves are produced and sold. We talk about the depletion deduction in more detail in MRP 105: What You Should Know About the Depletion Deduction.
Other Ways to Reduce Taxable Income (Can You Say Step-Up in Cost Basis?)
Contributing the maximum amount to retirement accounts is another strategy highlighted in the episode. While not directly related to minerals and royalties, contributing to tax-deferred retirement accounts can help minimize current-year tax liability while setting individuals up for long-term financial security.
For those who have inherited minerals and royalties, establishing a step-up basis can be a powerful tax strategy if you are planning on selling some or all of your interests. By obtaining a professional appraisal to determine the value of the minerals at the time of inheritance, mineral rights owners can potentially reduce their capital gains tax liability when selling the inherited assets.
Selling as a Strategy to Minimize Taxes
This may not seem intuitive but in some cases you could end up saving a significant amount of money in overall taxes by selling your interests for the right price as compared to paying income taxes on the royalties over the life of your wells.
When you sell minerals or royalties held for more than a year, you would be subject to capital gains taxes on the net gain. The long-term capital gains tax rate is typically 15% for most individuals and couples. If you are already in one of the higher marginal tax brackets and you expect to receive a significant amount of royalty income in the near future, that royalty income could be taxed your highest marginal tax rate (which tops out at 37% for 2023).
Even if you had a $0 cost basis and are subject to capital gains tax on the entire proceeds of the sale, paying 15% in taxes vs 37% is a no-brainer. It gets even better if you have inherited your mineral interests as you might be able to claim a step-up in cost basis which could further reduce your tax liability if you sell.
Here are the 2023 Capital Gains Tax Rates per the IRS:
Capital Gain Tax Rates
The tax rate on most net capital gain is no higher than 15% for most individuals. Some or all net capital gain may be taxed at 0% if your taxable income is less than or equal to $41,675 for single and married filing separately, $83,350 for married filing jointly or qualifying surviving spouse or $55,800 for head of household.
A capital gain rate of 15% applies if your taxable income is more than $41,675 but less than or equal to $459,750 for single; more than $83,350 but less than or equal to $517,200 for married filing jointly or qualifying surviving spouse; more than $55,800 but less than or equal to $488,500 for head of household or more than $41,675 but less than or equal to $258,600 for married filing separately.
However, a net capital gain tax rate of 20% applies to the extent that your taxable income exceeds the thresholds set for the 15% capital gain rate.
Internal Revenue Service – Tax Topic No. 409, Capital Gains and Losses
1031 Exchanges
Lastly, we discuss the option of deferring capital gains taxes through a like-kind exchange or 1031 exchange. This allows mineral rights owners to reinvest the proceeds from the sale of their assets into other similar types of investments, potentially deferring capital gains taxes. We talk about 1031 Exchanges in MRP 54: Using a 1031 Exchange to Defer Capital Gains Tax.
Summary
In conclusion, these are a few of the year-end tax strategies specifically designed for mineral rights owners (and some that aren’t). Since taxes can be complicated, it is strongly advised to consult with a qualified tax advisor who specializes in oil and gas taxation for personalized advice based on individual circumstances. By making sure you have a team of trusted tax, legal, and financial advisors, you can make informed decisions to maximize their allowable deductions and tax benefits. Again, this is being shared for informational purposes only and should not be construed as tax, legal, or financial advice.
Resources Mentioned in this Episode
Other Resources
- MRP 146: How Mineral Rights and Royalties are Taxed in 2022
- MRP 54: Using a 1031 Exchange to Defer Capital Gains Tax
- MRP 105: What You Should Know About the Depletion Deduction
- MRP 32: Rob Prentice on IRS Mineral Rights Valuation and the National Association of Royalty Owners
- MRP 97: How to Audit Your Oil and Gas Royalty Statements
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