Inherited Mineral Rights

If you inherited mineral rights, you probably have a lot of questions.

Mineral rights are complex and there is a lot to know.  This article will guide you through everything you need to know about inheriting mineral rights and what steps to take next.

There are a few things you should do after inheriting mineral rights.

Step 1:  The first thing you need to do is complete the process of getting the mineral rights put in your name legally.  Typically this is done through the probate process or through an attorney if there was a will.   This is an important step because your hands will be tied until the ownership is legally in your name.  Important:  Make sure that a document is filed in the county where the mineral rights are located showing that you are the new owner.  An attorney can assist you with this.

Step 2:  Determine the status of the mineral rights.  The mineral rights could have 3 different statuses:

Non-leased / Non-producing:  This means the mineral rights are not currently leased, and also not producing any type of royalty income.  Generally speaking, this means the mineral rights are not going to have any value currently.  There is nothing to do if the mineral rights are not leased or producing.

Leased:  The best way to determine if the mineral rights are currently leased it to check on Texas File.  You will want to search in the county where the mineral rights are located and see if any documents have been filed within the last 10 years.  On Texas File, you will search the name of the person you inherited from.   Look for any document titled “Lease Agreement” or “Memo for Lease”.   Any document that is related to an oil and gas company in the last 10 years would be worth getting for your records.  If you don’t see any documents filed within the last 10 years, there is not active lease unless the mineral rights are held by production (currently being paid royalties).  If the mineral rights are leased, it means you could get royalty income in the future.

Producing: If there is current royalty income being paid either monthly or every few months, these are producing mineral rights.  The best way to determine this is to check the bank statements for you relative and see if any money was being received.  Another alternative is to search their name on Mineral Holders.  If their name shows up on mineral holders, this will determine they have been getting royalties and it will tell you the location and operator.

Pay Status:  If the mineral rights are producing, you will need to get the ownership transferred into your name.  Contact the operator (company paying royalties) and speak to their “Division Orders” department.  They will start the process of transferring the ownership into your name so you can start getting paid the royalty income.

Suspense:  When you contact the operator, ask the company if there is any money being held in suspense.  If there was royalty income being generated, but payments stopped because the owner was deceased, that money will be collect and placed into suspense.  If there is money in suspense, ask them how much.  Once you are put into pay status, your first royalty check will include all the money held in suspense.

Escheatment: If there was money held in suspense, some money may have also be escheated to the state.  This is also known as “unclaimed property.”  After a few years, any money held in suspense must be sent to the state.  You can check under your name and the name of the person you inherited from at the Texas Unclaimed Property website.

Step 3:  Determine whether you want to sell the mineral rights or hold onto them.  Deciding whether to sell mineral rights is a personal decision.  Check out our article that covers the reasons to sell mineral rights.

It’s important to understand step-up basis for inherited mineral rights.

The decision to sell mineral rights or hold onto them may come down to your step-up basis.

The reason step-up basis is important for inherited mineral rights is that it determines how much you will owe in taxes.  When you inherit mineral rights in Texas, you get a step-up basis.

How does step-up basis work for mineral rights?

A step-up basis means that you get to use the market value of the mineral rights when you inherited them as your basis.

Wait, what is a basis?  A basis for tax purposes is how much you paid for the mineral rights.  Wait a second, I didn’t pay for them.  Correct.  That is what step-up basis is.  It lets you take the market value at the time of inheritance and treats it as if you had purchased the property for that price.   This is where the tax benefit comes in.

Let’s imagine you bought a house for $500,000.  Your basis in the house is $500,000 because that is what you paid for it.  If you sold it for $600,000, you would only pay taxes on the gain of $100,000 (sales price – basis = taxable amount).

Let’s imagine your uncle purchased a home for $250,000.  When they passed away, that home was worth $500,000 and you inherited the home.  Even though you didn’t pay anything for the home, the step-up basis tax rule allows you to have a basis of $500,000 in the home (market value when inherited).

It works the same way in mineral rights.  Regardless of what the family member paid for the mineral rights, your step-up basis in mineral rights is the market value at the time you inherit them.

How to determine market value when inherited?

As we have discussed, it is impossible to know mineral rights value until you sell.  If it’s impossible to know the value until you sell, how can you determine the market value when you inherited?  By working backwards.

The only way to determine the step-up basis of inherited mineral rights is at the time of the sale.  Once you have a current market sales price, you can use the inflation adjusted price of oil to determine your basis.

Visit Inflationdata.com to view the inflation adjusted price of oil.

How does that work exactly?  Let’s look at an example.

Example of step-up basis for inherited mineral rights

Let’s assume that you inherited mineral rights in 2018.  Looking at inflationdata.com, we see that the inflation adjusted price of oil was $63.10 in 2018.  Let’s assume that the price of oil when you sold was $80. Let’s also assume that the sales price is $1,000,000.

To determine your step-up basis, we use the sales price, current price of oil ($80/barrel), and inflation adjusted price of oil in 2018 ($63.10).

$1,000,000 sales price
X 78.875%  (63.10 / 80)
= $788,750  your basis

$1,000,000 (sales price) – $788,750 (basis) = $211,250 (amount you owe taxes on)

Let’s assume a 20% capital gains tax rate.  This means you would owe taxes on 20% of $211,250 or $42,250 in taxes.  That sounds like a lot in taxes, but this is actually just 4.2% of the total sales price of $1,000,000.

Note:  Inflationdata.com is always updating the inflation adjusted column, so the numbers may not match up perfectly.

Disclaimer: Speak with a CPA

We highly recommend speaking to your CPA.  The IRS has given no official guidance on how tax basis for mineral rights should work.  We believe that looking at the inflation adjusted price of oil at the time of sale is the most accurate way possible, but it is ultimately up to your CPA to determine the correct way to handle step-up basis for mineral rights.

If you inherited mineral rights and you have questions, please use the free consultation form below.  We can help answer your questions or point you in the right direction.