The explosion of oil and gas exploration and production in Bakken Formation of North Dakota has reaped great rewards for the farmers, ranchers and landowners throughout the region. But these payments from the producers can be confusing.
Jeffrey Stulken, CPA, Manager and Kevin Johnson, CPA, Manager have put together a brief guide for the three most common types of payments. Whether your land is in the Bakken Formation, the Powder River Basin of Wyoming or the Three Forks Formation in Harding County, South Dakota, the same rules apply when it comes to reporting this income.
Royalty — This is the most common form of payment. Strictly speaking, it’s the landowner’s interest in the oil and gas reserves found below the surface. The producer gets a share of the proceeds, and agrees to grant a share of the proceeds to the landowner. The royalties are reported on IRS Schedule E and are allowed a depletion deduction of 15 percent of the gross royalties.
Lease bonus — This is an amount paid by the producer for the right to go on your property and explore for oil and gas for a pre-determined period of time. It’s not considered the sale of property, but as rental income (Schedule E).
Damages — This one is a little more difficult to define, but it’ is often the amount of lost income that would have been realized if no oil-and-gas development had occurred. It’s the hay crop you didn’t harvest, or the value of the cattle you didn’t run. It can also refer to the actual damage done to the property during production. For tax purposes, the two are treated differently.
There is more. Check out the newsletter article from Stulken and Johnson, or contact one of the tax experts at Ketel Thorstenson LLP to see how these payments affect you personally.