Eligible for Depletion on Inherited Royalty Income?

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Permalink Reply by Kathy Morgan on March 2, 2009 at 4:39pm

Yes you can claim depletion on royalties that are inherited. You obviously have a legal right to the income but you also meet the first criteria. The reasoning that the IRS uses is that you have "investment" interest once you inherit the property because you inherit it with a basis. The person whom owned the royalty income before had a basis (basically their "investment") in the property/income and when you inherit the income you inherit the basis as well.
There are some adjustments to the basis made when you inherit it, but, the basic point is that there is one so you can claim the depletion. This only counts for actual extraction royalties, if you receive a bonus for signing a lease that is considered "advanced royalties" that is NOT subject to depletion.

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Permalink Reply by Suzanne Brown on March 2, 2009 at 5:31pm

Kathy -- thank you so much for the reply -- it is the first explanation I've been able to find that is logical, rationale, and supportable! The promptness of the response is also appreciated, especially given the time of year it is for you!

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Permalink Reply by Kathy Morgan on March 2, 2009 at 7:38pm

It probably doesn't surprise you that I spend about 75% of my time "translating" IRS-speak into "real" English. Most people actually understand a lot more about taxes then they think once it's broken down out of IRSeze. Kind of like breaking down algebra into basic math. (By the way, I really suck at algebra!)

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Permalink Reply by Big Daddy, bcnr on March 4, 2009 at 9:41pm

Kathy, I used the 15% depletion on my tax return this year. I noticed an alternate method of figuring the depletion allowance but really couldn't get a handle on it. Could you possibly decipher it for me and is it a viable option for the average royalty owner? Thanks, Cannie

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Permalink Reply by Kathy Morgan on March 5, 2009 at 8:28am

The other method is called cost depletions and it is a bugger bear. First you have to be able to determine your "basis" in the royalties. This entails knowing what your investment in the property is (ie. what you paid for it or its value when you inherited it), the cost of any improvements, the fair market value of any attachments (i.e. timber), minus the loss in value of any "damages" like that big old ugly well and pipeline. Once you get that figured out you take the depletion on all of that based on the number of years of viability of the well operation. The NEXT year you have to reduce those figures by what you took this year.
Clear as mud now? I HATE cost depletion. It is virtually impossible to get an accurate basis. The income depletion (straight 15% of the income) is much simpler and easier.
Of course this is why the new budget in congress is trying to do away with it. I've already written my people in Congress opposing this and hope you all will too. Most average royalty owners will just not bother to take any depletion at all and pay taxes on the whole thing. HHHmmmmm, could that be what the budget writers want and expect?

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Permalink Reply by Big Daddy, bcnr on March 6, 2009 at 9:07pm

Ohh, I get it now. ...NOT! Thanks to you Kathy, I do understand cost depletion now but it does not appear it is worth the extra effort to crunch the numbers. At least not for me. The 15% will do just fine for now. Thanks for breakin' it down for us.

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Permalink Reply by Larry T on August 18, 2009 at 11:24am

Kathy,

Do I understand you that I can take a 15% off of the lease bonus payment when filing taxes. There has been no drilling or royalties yet, even though the cost depletion is difficult, with a large bonus payment of around 1m, would you advise trying to go that way.

Any help appreciated.

LT

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Permalink Reply by Kathy Morgan on August 18, 2009 at 11:49am

Unfortunately the delpletion applies only to actual royalties for minerals extracted. You can not take it for the lease and/or bonus payments. Think about it this way, the delpetion deduction is for the "lessening" of available minerals and is based on the amount of minerals extracted. Therefore, there is no actual lessening of avavilable minerals/resources until they actually start drilling. Hope that helps.

Kathy

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