Appraisal for Mineral Rights

Shales Bakken Shale
21

Jaime, if you could reference what your attorney told you...so the rest of us could look it up, print it, and file it with our estate planning materials...that would wonderful. It does contradict (I think) the advice we were given when we settled my mother-in-laws estate...however as mentioned, at that time the appraisal was low so we did not come close to the inheritance tax...either federal or state.

So...if you could reference what your attorney said...in the tax code...I would sure appreciate this and I'm sure others would as well.

22

I will pass your request on to the attorney. He's very slow to answer, but hopefully he will be able to shed more light on the situation as it was given to me.

23

Andrew: I have been looking into doing this for my kids when I pass. Do you think it's the way to go?



Andrew Babcock said:

Greg, would this apply when creating a Trust exclusively to own the minerals or maybe a LLC?

24

We have all of our minerals in LLCs which are then owned by Trusts. Get a good estate attorney. Good planning now can save future generations a lot of hassle and taxes.

25

Andrew, I'm not sure what your question is, could you rephrase?

26

That's us too...however...I'm wanting to hear from Jamie as it's my understanding that when death occurs, the ownership value is taxable...even if it goes into a trust. A trust helps with probate but does not avoid taxes; at least that is my understanding. At my death, my stuff enters into a trust, but the value of what goes into that trust is still taxable for those who inherit. And, in my state (Minn), the inheritance tax kicks in at the 1 million dollar mark.

M Barnes said:

We have all of our minerals in LLCs which are then owned by Trusts. Get a good estate attorney. Good planning now can save future generations a lot of hassle and taxes.

27

I would like to comment on Jamie's comment. One needs to be careful about terminology. There is sometimes a difference between estate tax and inheritance tax. What I am talking about here is estate tax. The decedents estate pays the estate tax. The estate tax is based on the FMV of the property that passed in that estate. The income from the mineral right, lease bonus or royalties, is subject to income tax. The income tax is paid by the party who receive the income. This could be the estate if the income was received between date of death and before the assets were distributed to the beneficiaries.

The issue for estate tax is the value of the mineral rights. As others have said in this blog, income received from mineral rights increases the likelihood that the assets have value. What your attorney was saying was that without production the rights are worth nothing and therefore would result in no estate tax.

However, If an estate is required to file an estate tax return, form 706, mineral rights are required to be included on that return along with their value and support for that valuation. All forms 706 receive a review by a agent at the IRS.

So for estates with substantial value an appraisal of minerals rights might be a very good idea. Additionally there may be up-step in basis issue that may benefit the beneficiaries.

28

M Barnes, I was thinking of going with a Delaware Series LLC and just one Trust. I was looking into it but stopped when I was giving conflicting advice about whether MInnesota is friendly towards it, meaning even if I set them up in the ideal East coast state, it doesn't mean Minnesota won't punch me in the wallet every year per LLC. I need to put the PS3 down and get back to that research.........Greg, if a person inherits minerals, and a year later those minerals are producing, and the heir/owner now wants to put them into a LLC or Trust...(there is the confusing word, "Put"....we don't "Put" minerals into LLC's or Trust...don't we in fact "Sell" our minerals to the LLC or to the Trust since we no longer are the owners?......do we need an appraisal to do this? Would the person who is selling their minerals to the Trust need to pay the tax on the appreciation of the minerals over that one year period in which they were just minerals at the time they received them?

29

Andrew, The word “put” is often used when assets are transferred to a trust or LLC. Generally the transfer of assets to an LLC is a none taxable event. You simply have transferred assets that you owned to another entity that you own. However, one would need to be careful of gifts being made through transfers to LLC that are partnerships. A simple example would be where dad transfers mineral rights into a LLC that also has his three kids as members. If the kids didn't contribute any property but ended up with a 25% interest in the LLC, dad has made a gift to his kids. Their are reporting requirements if the value of the property is high enough and that reporting might involve an appraisal. There may also be gift tax due.

As a side note, a transferor’s basis in the LLC will be equal to the basis of the property transferred in. So although an appraisal is not needed for a simple transfer of property into a LLC, it might be a good time to look back and try to determine if the property had some significant basis.

Trusts are as they say, a purple horse. I would think that in these cases, trusts are used to go around probate. In some states, such as California, probate costs are a percentage of assets that are run through probate and can be quite high. So what folks do is set up what is called a revocable trust. Sometimes these trust are called living trust, grantor trust, or defective trust. Because the maker of the trust can take the assets back, the trust is disregarded for tax purposes as a separate entity. The maker still reports income from the assets on their return, the assts still get up-step in basis upon the death of the maker and the value of the assets is still included in the makers estate for estate tax proposes. When the maker dies the trust becomes irrevocable and then the trustee can distribute the assets to the beneficiaries. The only effect is that the assets were kept out of probate.

Sometimes estate planning for high net worth individuals will include an irrevocable trust. In this case the trust is a separate entity for tax purposes. The transfer of assets into the trust is not a sale. But it is a gift and subject to those rules and tax. An appraisal might be required.

As I said before, tax code is complex and can bite you, so it is very important to get advise from the professional who is qualified to consult about such issues.

30

Here is what my siblings and me did with the mineral rights that we inherited and the reasons why.

Here are some facts: My brother and me live in Washington State. Our sister lives in California. The mineral rights are located in Williston and McKenzie counties in North Dakota.

Our mom lived in Washington State when she died. So the assets needed to be included in her estate for purposes of the Washington State estate tax and probate. Washington is not an expensive probate state so no living trust was in place. Washington’s estate tax starts at $2M. We knew that her estate would be well under that amount, so we did not get an appraisal of the rights. An amount needed to be reported for probate. I did some research and applied a per acre amount based on that research. Because I didn't want the risk of the state asserting that I estimated low to avoid the tax or reporting requirements, I estimated high. I included a letter and other documents in the estate filing to support the valuation.

You may be asking why if there is an up-step in basis, why not get the appraisal? Well, it does cost money. And in our case mom told us that granddad said to never sell the rights. He was right, we just complete a lease that paid us a bonus of over $50K. Additionally it appears that the common wisdom is not to sell Bakken mineral rights. If there will be no sale in the future, then no need for a good supportable basis number. But on the other hand things change and maybe one of use needs or wants to sell. Then what will I do? I will probably use the number I can up with during the administration of the estate, which is probably higher than what an appraisal would have given me. There is risk here. In the event that the IRS looks at this potential transaction, I may not be able to support the value to their liking and therefore pay tax on the entire sale price.

Because the property is located in North Dakota, we needed to do an auxiliary probate in that State. In short I hired an attorney that took care of this. I was never asked for a value of the assets. As part of the of the probate work in North Dakota, the attorney also handled the title transfer to my siblings and me.

After this transfer was completed, I sent up a LLC in Washington State that will be taxed as a partnership and all three of us quick claimed our rights into the LLC. Here are the reasons:

  • To make it easier to transfer the rights from on generation to another.
  • To be able to negotiate leasing of the rights as one.
  • To make it easier for potential leasers to find us.
  • To take advantage of a discount due to lack of marketability which should allow us to use lower valuations for the purposes gifting and or estate tax.

As I have said, often time residents of California set up revocable trust to bypass probate in that state and save some money. If my sister, who lives in California, chooses to, she could set-up a revocable trust and transfer her ownership interest in the LLC to the trust. Thus receiving the benefits of the LLC and the trust.

I must say it again. Tax issues are complex. You must get good advise. I, a CPA that prepares trust tax returns on a regular basis would not undertake a trust strategy without the advise of a well qualified attorney.

31

Advised to get good advice!

32

Is your LLC set up to do business in North Dakota?? We had to register our LLC in Montana so we were able to conduct business in Montana. Thus, we registered through a company called LAWCO for $100 a year. Both of our LLC's were required to do this...again...in order to do business as an LLC in Montana.

Greg Campbell said:

Here is what my siblings and me did with the mineral rights that we inherited and the reasons why.

Here are some facts: My brother and me live in Washington State. Our sister lives in California. The mineral rights are located in Williston and McKenzie counties in North Dakota.

Our mom lived in Washington State when she died. So the assets needed to be included in her estate for purposes of the Washington State estate tax and probate. Washington is not an expensive probate state so no living trust was in place. Washington’s estate tax starts at $2M. We knew that her estate would be well under that amount, so we did not get an appraisal of the rights. An amount needed to be reported for probate. I did some research and applied a per acre amount based on that research. Because I didn't want the risk of the state asserting that I estimated low to avoid the tax or reporting requirements, I estimated high. I included a letter and other documents in the estate filing to support the valuation.

You may be asking why if there is an up-step in basis, why not get the appraisal? Well, it does cost money. And in our case mom told us that granddad said to never sell the rights. He was right, we just complete a lease that paid us a bonus of over $50K. Additionally it appears that the common wisdom is not to sell Bakken mineral rights. If there will be no sale in the future, then no need for a good supportable basis number. But on the other hand things change and maybe one of use needs or wants to sell. Then what will I do? I will probably use the number I can up with during the administration of the estate, which is probably higher than what an appraisal would have given me. There is risk here. In the event that the IRS looks at this potential transaction, I may not be able to support the value to their liking and therefore pay tax on the entire sale price.

Because the property is located in North Dakota, we needed to do an auxiliary probate in that State. In short I hired an attorney that took care of this. I was never asked for a value of the assets. As part of the of the probate work in North Dakota, the attorney also handled the title transfer to my siblings and me.

After this transfer was completed, I sent up a LLC in Washington State that will be taxed as a partnership and all three of us quick claimed our rights into the LLC. Here are the reasons:

  • To make it easier to transfer the rights from on generation to another.
  • To be able to negotiate leasing of the rights as one.
  • To make it easier for potential leasers to find us.
  • To take advantage of a discount due to lack of marketability which should allow us to use lower valuations for the purposes gifting and or estate tax.

As I have said, often time residents of California set up revocable trust to bypass probate in that state and save some money. If my sister, who lives in California, chooses to, she could set-up a revocable trust and transfer her ownership interest in the LLC to the trust. Thus receiving the benefits of the LLC and the trust.

I must say it again. Tax issues are complex. You must get good advise. I, a CPA that prepares trust tax returns on a regular basis would not undertake a trust strategy without the advise of a well qualified attorney.

33

David, Yep LLC's do need to be registered with the State of North Dakota to do business there. Although I wonder if holding property in an LLC is considered doing business. In IRS speak investment activities is not considered trade or business. I will make a call tomorrow.

Another thing that some out of state mineral rights owner may not realize is that income from mineral rights located in North Dakota is taxable to that state. In the past the level of income was small and maybe didn't result in any state tax. But as the size of lease bonuses royalties rise, more folks may have some state tax liability that they are not aware. From what I have seen in my practice, it appears that the Oil Companies are a little hit or miss on reporting the income to the state.

34

I received a letter a couple of days ago from KOG saying the state now requires them to withhold 3.22% for state income tax.

35

Our LLC shareholders live all over the country. The LLC was created in OK, but owns property in ND and OK, so we have to file paperwork in ND to do business there. Last year, the form was SGN-17156 North Dakota Foreign Tax (essentially a license to do business since we do not reside there $25). We also filed ND 60. We also had form BT-190 OK franchise tax of $25, but I think it was the last year we had to pay. Probably still have to file. We had to file 512-S-OK OK partnership tax return. We do pay state income tax in OK (on OK revenue) and ND (on ND revenue), but depending upon the state and the federal taxes, sometimes it is refunded. Pretty complicated, but worth it. The state taxes are pretty small % since they have incentives for all this horizontal drilling-at least for now.

So get a good attorney and a good accountant!

Each of our shareholders also decides where the ownership of the LLC resides to get the best tax benefit and estate planning benefit for his or her family. Some folks have it in a revocable trust, some have in irrevocable, some keep it separate. It depends upon the state they live in and the rules there.

We have 30 ultimate beneficiaries to our mineral rights, so I sure don't want to be filing paperwork in every county in every state and notifying every company when a person passes away. By having all the title to the mineral rights in an LLC and one PO Box address, the title stays stable and has for generations past and to come. Companies can find us and makes doing business easier. We get our royalty checks faster as well since we don't have title problems nearly as often.

36

The IRS generally values producing minerals at 3X annual revenues for purposes of the estate tax caps, and 1x the bonus for leased but non-producing minerals.

37

Jainie, I sent you a friend request and brief instructions on how to start a thread.

Janie Newborg said:

Andrew: I have been looking into doing this for my kids when I pass. Do you think it's the way to go?



Andrew Babcock said:

Greg, would this apply when creating a Trust exclusively to own the minerals or maybe a LLC?

38


This is exactly how estate tax works. The estate tax is a tax on the FMV of an assets because of death and income tax is a tax on income produced. There is one saving grace however. The assets get an up-step in basis to FMV at time of death. This means that if mom sold her rights for $6K the day before she passed, she would pay tax on the entire or close to the entire $6K. If one the kids sold the rights after receiving them form the estate, all of the gain would go away. Even if an estate doesn't have an estate tax problem, it might be worth trying to pin down the vale of mineral rights to reduce tax on a sale in the future.

FrakinAndy said:

I am by no means an expert. But it would seem to me that mineral rights leased or unleased have no actual value unless they are currently producing a royalty. Lease money paid in the past would be part of the assests of the deceasts (sic) estate. With transfer of the mineral rights going forward, the inheritees would then pay taxes on what is newly leased or produced. Why should taxes be paid for some "value" of the ownership and then pay taxes again when the lease actually produces revenue.

39

FMV at time of death may be very important to heirs in helping them make future decisions as Mr. Campbell states. Use of that information can be tailored to the specific needs of the estate and heirs within the laws. Where minerals are involved, estimates are necessary for documentation of FMV. In my experience most government agencies accept scientifically based calculation of RESERVES, a narrowly defined term of art developed by the USGS and accepted by financial watchdogs like the SEC and regulatory agencies like the BLM and executive orders concerning mineral exploitation. Tax rules for gifted mineral rights can go beyond the strict definition of Reserves and, in some cases may allow the documented expectation of the mineral owner just prior to death in establishing a stepped up basis for estate heirs as Mr Campbell uses in his example.

With the increasing number of large dollar mineral rights sales expected in the future and the large estate tax exemptions, FMV and Expected Value will become more important.

In my years of applying science to economics for appraisal purposes, the only agency that wanted to apply RESOURCES (another definition by USGS) to minerals has been a Montana Medicaid agent.

40

Another advantage to having your mineral rights in an LLC (instead of held personally) is that they are further discounted for IRS purposes in the estate tax computation for being in a privately held company, not on a stock exchange and having a minority interest, etc. This further discount can be about 35-40% if done properly.

Also, the LLC holds the title to the minerals, so it keeps the title path clear. People or trusts can then own shares in the LLC and you don't have to keep changing the title to the minerals. Get a good estate planning attorney to put it together and it helps out future generations.