Oil and Gas Leases

[Koss]

Can someone give me the Cliff's Notes version of this?

I've done some reading, and apparently there are several different types of income associated with oil and gas leases. The most important distinction seems to be:

(1) the initial lease payment, before drilling and exploration begin;

(2) delay rental payments, to extend the lease, before drilling and exploration begin, and

(3) royalty payments, which are the landowners's share of the income that arises once the property is actually producing oil.

I've also read that initial lease payments are treated as ordinary income.

My client is the landowner.

How do we report the initial lease payments?

Is he simply renting raw land? Reported as rental income on Schedule E, with no depreciation or depletion?

My understanding is that the depletion deduction is only applicable to royalty payments.

Am I getting any of this right? LOL

BMK

[Jiggers]

Oil and gas leases go on Schedule E. I code it "8 Other" and the description is "Oil & Gas Lease".

The only expenses probably are the legal fees that may be paid to attorney to review the lease.

If the payment was made through a bank draft, there is a bank fee for handling. That is also deducted.

You do need to put in the address of the property on the Schedule E. And you have to show 365 days rental.

Royalty for oil and/or gas is a different ball game. Normally there is a 15% percentage depletion allowed. This is on the gross payment, not the net. The 1099 may or may not be correct. It may show the gross or the net. I ask my clients to keep their check stubs just in case the net is shown.

From the gross there is usually a state severance tax on the oil. There could also be transportation or other expenses. A perfect 1099 will show the gross and somewhere on the 1099 or attachment there is the state severance tax and any other expenses.

Some states or taxing entities will also have a property tax on the royalty property. That is deducted in addition to the state severance tax.

My version of Cliff Notes or Oil and Gas 101.

[Koss]

Oil and Gas

Thanks!

Very helpful.

BMK

[Jiggers]

Just be sure that the payment isn't for an easement. That should not be reported on a 1099MISC. It should be on a 1099S.

And if it is for seismic work/damages, this should be in the "Other" box. Where does it go on the return? Depends.

If it is a farmer, and the farmer is using the land for farming or raising cattle, the funds for seismic work/damages goes on the Schedule F, Other Income.

If it is someone that just has land, doesn't farm it, or have income on it, I put on the 1040, line 21.

[AJsTax]

seismic work

Just be sure that the payment isn't for an easement. That should not be reported on a 1099MISC. It should be on a 1099S.

And if it is for seismic work/damages, this should be in the "Other" box. Where does it go on the return? Depends.

If it is a farmer, and the farmer is using the land for farming or raising cattle, the funds for seismic work/damages goes on the Schedule F, Other Income.

If it is someone that just has land, doesn't farm it, or have income on it, I put on the 1040, line 21.

Seismic work may have two types of payments IF there is crop damage. If it is only for the right to go onto the land and do the testing is it rent, same as the lease bonus payment, SCH E item. If it is for crop damage it is a sch F income item. There is no permanent easment or damage to worry about with seismic testing, except maybe to the poor employee that came walking across my farm and nearly got shot during deer season.
In answer to the OP, the initial (bonus) lease payment and delayed(shutin) payments are rent on Sch E with no depletion allowed. You are correct, you must be removing the asset to take depletion.