Tax Implications of EnergyChapter 6 pp. 145-1602018 Agricultural Tax

Issues

Chapter 6: Tax Implications of Energy-Related Payments pp. 145-159

Tax IssuesRental paymentsDamage paymentsEasement paymentsPayments for transfer of mineral rightsOil and gas depletion

Rental Payments pp. 145-146

Wind Turbines and Wind Farms Annual payment per tower Annual royalty payment per kilowatt of

electricity generated Combination of the above Payments reported on Sch E (Form 1040) Payments not subject to SE Tax

Rental Payments pp. 146-147

Solar-Panel Farms Annual rent payment based on the acres

covered by panels Rental payments reported on Sch E (Form

1040) Payments not subject to SE Tax

Rental Paymentsp. 147

Oil and Natural Gas Production Temporary easement for constructing a

pipeline (treated as a rental payment) Payment reported on Sch E (Form 1040) Payment not subject to SE Tax

Damage Payments pp. 147-148

Tax Issues Crop damage Treated as sale of crop Reported on Line 2 of Sch F, (Form 1040) Subject to SE Tax Soil compaction, timber, or land damage Reduce basis first Any excess is § 1231 gain Tile damage is often repaired by company

Permanent Easement Payments pp. 148-149

30 years or longerTreated as sale of property interestReduce basis first, any excess payment is gainSale of an permanent easement – determining basis (Treas. Reg. § 1.61-6(a)): Allocate basis between property affected and

not affected Allocate basis of affected property between

rights sold and rights retained

Property Affectedp. 149

Iske v. Commissioner – unsuccessful claim that entire parcel was affected

Ex. 6.3 Allocate to 20 acres of 600 acre farm Cases where entire parcel was affected Bledsoe – fenced easement affected cattle Inaja Land – flooding and fish kill Ex. 6.4 – Building restriction affects total parcel?

Revenue Ruling 77- 414 p . 150

If it is impossible to allocate basis between rights retained and sold,then the easement sale proceeds

can be compared tothe entire basis in land

affected by the easement.

Pipeline Right-of-Way Easementsp. 150

Perpetual (permanent) easement: the right to lay, construct, operate, maintain, inspect, remove, alter, abandon in place, replace, relocate, and reconstruct a pipelineTemporary easement: occurs during the construction period and is rental income reported on Sch E (Form 1040)

Perpetual Easements

p. 150

Payment for the easement reduces basis on land affected by the easementPayment amount that exceeds basis is IRC §1231 gain

Pipeline Right-of-Way Easementspp. 150-151

Temporary and Permanent EasementsExample 6.5 Basis Allocation to ROW50 foot permanent easement payment amount is reported on Form 479775 foot temporary easement payment amount is reported on Sch E (Form 1040)

Eminent Domainp. 151

If forced to grant easement under eminent domain:Involuntary conversionTaxpayer can defer gain by reinvesting within 3 years

Transfer of Mineral Rightspp. 151-152

Sale of mineral rightsSection 1231 gain or lossMineral owner must prove cost basis or inherited basis as of date of acquisitionEx. 6.6Lease of mineral rightsMineral owner reports payments in Sch E (Form 1040)

Lease Payments pp. 152-153

Lease Bonus: paid when lease is signed for a time limited right to exploreTreated as an advanced royaltyOrdinary income subject to cost depletionRefer to Example 6.7Delay rental: paid to defer production Ordinary income; no depletion allowedRefer to Example 6.8

Advance Royalties

pp. 153-154

Paid for specific amount of extraction even if production units are still in groundEligible for cost or percentage depletion (production based)Refer to Example 6.9Minimum royalties are advance royalties

Oil and Gas Depletion

p. 154

Owners of an economic interest in oil or gas can claim a depletion deduction to recover their capital investment in the amount sold or consumed.The deduction is the greater of:

1. Cost depletion, or2. Percentage depletion

Cost Depletion

pp. 155-56

Estimate reservesDivide adjusted depletable basis by remaining oil or gas to get unit costMultiply unit cost by number of units sold to get cost depletion deductionMust use the entire quantity (amount depleted plus the entire reserve) to determine the per unit allowance

Ex. 6.11: Cost Depletion (Royalty Interest) pp. 155-156

Slate RockAdjusted basis = $ 22,000Estimate reserves (barrels) = 35,000Amount sold (barrels) = 5,000Cost depletion amount = $ 2,750

Percentage Depletion

pp.156-157

Allowed even if tax basis is zeroGenerally, 15% of gross incomeLimited to taxable income of the propertyCumulative percentage depletion for all of the taxpayer’s properties is limited to 65% of adjusted taxable income from all sources

Gross Income p. 157

Normally, gross royalty interestRoyalty interest based upon a percentage of production (1/8, 3/16, 1/20, etc.)Gross income does not include lease bonus or advance royalty payable without regard to productiondelay rental payments and most land damage payments

Taxable Income from the Property p. 157

Gross income from the property minus all allowable deductions (except any deduction for depletion or domestic production activities) attributable to the mining processes, including mining transportation (same as gross income for most mineral owners)

Taxable Income from All Sourcesp. 157

Percentage depletion deduction for all properties may not exceed 65% adjusted taxable income from all sources for the yearAdjustments eliminatenet operating loss carrybacks;capital loss carrybacks;percentage depletion; anddistributions to trust beneficiaries.

Ex 6.12 Sufficient Taxable Income (Royalty Interest) p. 158

Gross income $55,000Royalty check (taxable income limit) $51,700Adjusted taxable income $120,000Percentage depletion (15% of $55,000) $8,250Gross income limit ($120,000 × 65%) $78,000Remaining basis ($22,000 - $8,250) $13,750

Working Interest pp. 158-159

Working interest is an operating interestOwner bears all production costsReported as business income Sch C (Form 1040)Subject to SE Tax unless passive investment

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