Understanding Royalty Taxes for Mineral Rights and Royalties

County Ad Valorem Tax

Ad Valorem (Latin for according to value) taxes are levied at the County level and are generally viewed as a property tax on mineral rights, similar to the tax you pay on your residence. In most states, this tax becomes payable only when minerals are producing (as opposed to non producing), and are billed and collected once per year. Read more about county ad valorem taxes in the article titled County Ad Valorem Tax.

Federal Income Tax

Under the IRS code, royalty revenues are considered ordinary income and are taxed as such. You can read more about income taxes in the article titles Oil & Gas Mineral and Royalty Income Taxes.

Depletion Allowance

Fortunately, there are ways to reduce your mineral rights and royalty taxes. The depletion allowance is one way to accomplish this. Since minerals are a finite source and will eventually play out, the IRS code generally allows royalty owners to deduct up to 15% of the income from their mineral interests. Read more about this royalty tax saving strategy in the article titled Depletion Allowance.

1031 Exchange for Mineral Rights

1031 exchanges are a great way to defer paying capital gains taxes on the sale of oil & gas minerals. This type of exchange is based upon section 1031 of the IRS code which allows capital gain taxes to be deferred on the sale of properties like mineral rights which are then exchanged for other properties considered to be "like-kind.” Such items may include investment properties or other mineral interests. Read more about 1031 exchanges in the article titled 1031 Exchange for Mineral Rights.