How to value oil & gas lease on Form 706

[tpnl]

Client has ownership of a paid-up Oil and Gas Lease. Original term is 5 years with an option to renew for another 5 year term. Initially payment was $80,000 in 2011 and won't receive anything else until the company decides if it will extract the oil or gas on the property. Or will receive another payment if the lessee decides to extend for another 5 year term in 2016. The lessee will not (does not have to) disclose the mineral findings. If extraction occurs, lessor receives 15.5% of revenue of marketed product less expenses.

The client wants to gift the rights to the lease to his two children (lease will allow for this transfer). Client is 83 years old and not in good health. This is not to avoid paying for medical care, client is not gifting away any other assets he owns, and would not qualify for free medical care based on his other assets. This could be a sizable amount of money if there is gas/oil and it is extracted and sold. This could be worth nothing if there is no gas/oil or not enough to justify extraction. The client doesn't need the money and would like for his children to have ownership of it. Advantage of doing so is, if client starts receiving payments and there is a big gas/oil field under his property, he could have to pay estate tax when he dies. He just want to gift it to his kids.

How do I place a value on something that could be worth nothing or lets say $10 million? Does anyone know of publications (I looked at the instructions for 706) I can look at for guidance of how to value this lease?

Thanks,

Kerrie

[TAXNJ]

Something

Client has ownership of a paid-up Oil and Gas Lease. Original term is 5 years with an option to renew for another 5 year term. Initially payment was $80,000 in 2011 and won't receive anything else until the company decides if it will extract the oil or gas on the property. Or will receive another payment if the lessee decides to extend for another 5 year term in 2016. The lessee will not (does not have to) disclose the mineral findings. If extraction occurs, lessor receives 15.5% of revenue of marketed product less expenses.

The client wants to gift the rights to the lease to his two children (lease will allow for this transfer). Client is 83 years old and not in good health. This is not to avoid paying for medical care, client is not gifting away any other assets he owns, and would not qualify for free medical care based on his other assets. This could be a sizable amount of money if there is gas/oil and it is extracted and sold. This could be worth nothing if there is no gas/oil or not enough to justify extraction. The client doesn't need the money and would like for his children to have ownership of it. Advantage of doing so is, if client starts receiving payments and there is a big gas/oil field under his property, he could have to pay estate tax when he dies. He just want to gift it to his kids.

How do I place a value on something that could be worth nothing or lets say $10 million? Does anyone know of publications (I looked at the instructions for 706) I can look at for guidance of how to value this lease?

Thanks,

Kerrie

Something to start with

http://www.mineralweb.com/owners-guide/oil-and-gas-basics-for-mineral-owners/

[tpnl]

I Googled the topic . . .

and found that same article. I have read many that talk generally about the industry, but have yet to find anything that talks about how to value the lease.

[Gretel]

I looked into this some months ago for a deceased client's joint trust. Basically, I think you need to get an evaluation. Value heavily depends on the location and how likely it is to find a substantial amount of minerals. An appraiser will take all these factors into account. My information leaned towards rather a small value as long as it is just the rights and no production yet. I might have some more information in my office. I also will have a meeting with my client and a lawyer and addressing this issue since about 20 mineral rights are involved, none of them producing and obtained about 50 years ago.

[TAXNJ]

Excellent

I looked into this some months ago for a deceased client's joint trust. Basically, I think you need to get an evaluation. Value heavily depends on the location and how likely it is to find a substantial amount of minerals. An appraiser will take all these factors into account. My information leaned towards rather a small value as long as it is just the rights and no production yet. I might have some more information in my office. I also will have a meeting with my client and a lawyer and addressing this issue since about 20 mineral rights are involved, none of them producing and obtained about 50 years ago.

Unless the original poster is a Professional appraiser and certified to do an evaluation your points are Excellent points and all revelant parties involved to reach the agreement. It the proper way of handling it

[tpnl]

Appraisal might be good way to go . . .

but they are very expensive. The company who did the studies to find out what exactly is underneath the land does not have to disclose what they found.

I have found out since I posted yesterday, that many of the companies that took out these leases are letting them expire with the price of gas and oil being down. (this might be a geographical thing and not a US as a whole thing.)

I also found this http://www.mineralhub.com/questions-and-answers/ and one of the questions/answers said the lease could be valued the same way producing mineral rights are (3 times the prior 12 month period). Meaning the $X,XXX client received times 3 equals $XX,XXX.

I have already, during my first meeting, told them they should get a mineral appraisal. That is when I was clued in on how expensive they are. I let them know, the IRS doesn't care how much they cost, if the value the assign is questions, the IRS will won't to know how they determined it.

[TAXNJ]

tax work or the appraisal ?

but they are very expensive. The company who did the studies to find out what exactly is underneath the land does not have to disclose what they found.

I have found out since I posted yesterday, that many of the companies that took out these leases are letting them expire with the price of gas and oil being down. (this might be a geographical thing and not a US as a whole thing.)

I also found this http://www.mineralhub.com/questions-and-answers/ and one of the questions/answers said the lease could be valued the same way producing mineral rights are (3 times the prior 12 month period). Meaning the $X,XXX client received times 3 equals $XX,XXX.

I have already, during my first meeting, told them they should get a mineral appraisal. That is when I was clued in on how expensive they are. I let them know, the IRS doesn't care how much they cost, if the value the assign is questions, the IRS will won't to know how they determined it.

CONGRATS. Sounds like you are doing your homework. What is your responsibility - tax work or the appraisal ?

Reminds me of the time when going over a client's tax return with them and they said they are "getting a headache" and what should they do? I said best to call your doctor and if treated by your doctor, I could tell you if the visit to the doctor might be tax deductible!

[Gretel]

but they are very expensive. The company who did the studies to find out what exactly is underneath the land does not have to disclose what they found.

I have found out since I posted yesterday, that many of the companies that took out these leases are letting them expire with the price of gas and oil being down. (this might be a geographical thing and not a US as a whole thing.)

I also found this http://www.mineralhub.com/questions-and-answers/ and one of the questions/answers said the lease could be valued the same way producing mineral rights are (3 times the prior 12 month period). Meaning the $X,XXX client received times 3 equals $XX,XXX.

I have already, during my first meeting, told them they should get a mineral appraisal. That is when I was clued in on how expensive they are. I let them know, the IRS doesn't care how much they cost, if the value the assign is questions, the IRS will won't to know how they determined it.

For the same client I had them get an "appraisal" for the home and home land. I put "appraisal" in quotes since there a different types. Banks always want to have a full appraisal, however, for the purpose of establishing FMV an evaluation was good enough and way less expensive. I certainly would want to asks these questions of an appraiser, a good one should actually suggest a cheaper options but of course, first he needs to understand what this "appraisal" is supposed to do.

[tpnl]

We are doing the tax work

and the client had questions on how to value the gift to this children. (my client is giving the rights to the lease to his two children.) We will NOT assign value to the gift, the client will have to tell us how much it is worth. But to cover myself, I am putting very detailed notes in the file that we provided no assistance in the valuation process, except that we recommended an appraisal and that the client speak with an attorney. We are finding out, this issue is complicated, more than we feel comfortable dealing with.

Side note: if we don't feel comfortable with how the value was arrived at, we won't do the return.

THANKS for all the input!!!

Kerrie

[DaveinTexas]

Local Tax Assessor

Around here in these here parts of Texas (the greatest State in the Union) we have a local (county) tax assessor that assesses their values to mineral rights and taxes the property based upon the taxable value.

That might not be a bad start, it's what the IRS would use in a Collection case (typically, minus say 20%). Some call them "dem tax rolls", see if this gets you Googlin' or noodlin' in the right direction.

[DMICPA]

706 or 709

Wouldn't this valuation issue be under the gift tax rules? That is form 709.

[AJsTax]

Oil and gas rights

I sit on top of one of the most active areas in Ohio for this type of income.
The person above stated one thing I noticed right away: 709 for gifts. 706 is estate. ( how I remembered that is to go to the alphabet: E is before G, 706 is before 709. That worked on the exams for me!)
The client does not own a lease. The O&G company owns the lease, the taxpayer owns the mineral rights leased to the O&G company.
There have been a lot of sales around here of just the mineral rights lately. If you are in the eastern Ohio area a qualified real estate appraiser can supply you with comparable sales very easily.
You are right in that the leased minerals could be valuable or could be worthless for another generation or two.
One thing to consider is that if he allows the rights to transfer at death the heirs would get a stepped up basis. Gifting will transfer his basis in the minerals. You need to know the FMV also but that is not the value the heirs would use for basis of a sale. The chance of the mineral rights tripping the Current Estate tax are very slim unless he owns thousands of acres. His lease bonus payment does not equate to more than a few acres. That all depends on how well he was able to market his lease.
These have been very interesting times around here and very trying times. The lawyers and appraisers are still learning every day how to handle these assets that only a few years ago had no value. Our real estate tax system here does not assign a value to those minerals until there is actual production.