oil/gas exploration lease income


E

effi

hypothetical:
taxpayer receives prepaid lump sum lease payment to cover 3
year period wherein lessee will drill (exploration) to try
and find oil/gas

what kind of income is the lease payment (schedule e rental
income?)and is it reported all in the year of receipt, or
taken into taxable income over the 3 years?

how would destruction of property (clearing of trees for
drilling site, etc.) be reported by lessee? is tax basis of
property adjusted?

would it be typical for the lessor drilling company to pay
for the value of trees cleared and any other property
destruction, in addition to lease payments paid to lessor
over the 3 years?

if oil and/or gas is found by lessee, under agreement lessor
would get a fraction of the total produced as income. what
would be the nature of that income and how would it be
reported on individual federal income tax return?

any other relevant issues not raised herein regarding this
kind of scenario?
 
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P

Phoebe Roberts, EA

what kind of income is the lease payment (schedule e rental
income?)and is it reported all in the year of receipt, or
taken into taxable income over the 3 years?
Lease bonus is a royalty, not eligible for percentage
depletion, taxable in the year of receipt.
how would destruction of property (clearing of trees for
drilling site, etc.) be reported by lessee? is tax basis of
property adjusted?
Surface damages reduce basis of the property covered by the
payment, and are capital gains to the extent they exceed
basis.
would it be typical for the lessor drilling company to pay
for the value of trees cleared and any other property
destruction, in addition to lease payments paid to lessor
over the 3 years?
Yes, but value as they see it and value as you see it may
differ. The payment is surface damages (see above).
if oil and/or gas is found by lessee, under agreement lessor
would get a fraction of the total produced as income.
That would be a royalty interest.
what would be the nature of that income
Ordinary.

how would it be
reported on individual federal income tax return?
Schedule E, as a royalty, eligible for percentage depletion.
any other relevant issues not raised herein regarding this
kind of scenario?
You may have some state issues; Oklahoma allows small
producers 22% percentage depletion. I don't know how
hypothetical your scenario is, but around here, it's
relatively unusual for the person who owns the top of the
land (where the house is) to also own the mineral interests.

Phoebe :)
 

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