Ad Valorem Taxes

Ad Valorem taxes on minerals are levied at the County level. Ad Valorem is Latin for according to value. In Texas (and in some other states), this tax becomes payable only when minerals are producing (as opposed to non producing), and are billed and collected once per year.

Mineral interests are classified as real property, and are taxed based on the appraised Fair Market Value. In its simplest form, fair market value is the price a willing buyer from the open market will pay for a mineral interest within the currently prevailing market conditions. In Texas the collection methodology is that of placing a tax lien upon producing mineral interests on January 1 of each year. Ad Valorem taxes are levied in addition to state severance taxes.

Market Value

Now comes that all important conversation regarding the “fair market value” of an owner’s interest. Like all taxpayers, we’d like to pay as little in tax as possible, and in this case, it means minimizing the fair market value. As you might suspect, the state has an appraisal method that must be used, which attempts a fair handed evaluation for all. The market value of a mineral interest in a producing well is deemed to be the prorata share of the total future recoverable reserves to be produced in the future, discounted to reflect their present worth. In other words, the market value upon which you are assessed county ad valorem tax is the value of the discounted cash flow estimated from future production. Again, this appraisal methodology is mandated by the state of Texas. It is important to understand that county ad valorem taxes on minerals are NOT in income tax on the prior year’s revenue.

The Discounted Cash Flow Calculation

There are 4 variables which contribute to the discounted cash flow (DCF) method of valuation of mineral interests:

• The production profile (aka production decline curve) - An estimate is made as to the flow rate expected over the course of the coming year.

• Operating expenses - Total lease operating expenses are taken into account, since they have a direct bearing on the commercial viability of the producing lease.

• Oil and Gas Prices - An estimate of prices is made, with consideration given to lease location and the hydrocarbon quality.

• Discount Rate (aka the cost of money) - As in any calculation involving future cash flows, a discount factor must be applied in order to account for the time value of money. Time value of money is the concept that a dollar in hand today is worth more than a dollar to be received in the future.

County Ad Valorem Tax Collection

Every year about March, the county appraisal district will mail mineral owners an assessment of value on their minerals. Owners have the opportunity to protest this value should they desire. In fact, Oil and Gas Mineral Services can help in this regard. Contact us today.

This article pertains specifically to oil and gas ad valorem taxes in Texas. As time allows, we’ll develop articles for additional states. However, many states currently follow the methodology used in Texas.