Recently sold an inherited ORRI. Inherited in 1995 and no previous production where interest sold. Obviously, federal income taxation would be capital gains. My concern is how to set cost basis which would be acceptable to IRS. No production has come from Royalty interest sold. Can someone refer me to an opinion on this matter? Surely, IRS has had this situation before.
Its is going to be very close to zero. In any sort of accurate assessment. Long term cap gains isn’t the worst way to make money.
I mean there is a pretty good chance that nobody is going to dispute what you put down. But…that way lies madness and the small chance of a real uncomfortable audit.
Yes, that is what I am thinking. The price of oil was very low compared to today’s market. But, I was thinking not zero. So, it is appears to be arbitrary, but needs to be defensible in the case of an audit. Understood.
Yes its not zero, but it’s close. Basically to “do it right” you’d have to take yourself back to 1995, not just on oil price but more importantly on “what sort of wells might this acreage have in the future?”. I’m not sure where you are in Eddy Cty, but chances are that horizontal wells that are viable there today were not even a twinkle in the engineers/geos eye back in 1995.
So much much much less reserves on your acreage in the 1995 version. Much less future cash flow, much less NPV. Etc. In 1995 at $19 oil I kinda doubt any of this was worth anything significant.
It has to be defensible if somebody makes you defend it. Which might happen. I kinda doubt it, but maybe. And how defensible it has to be is purely a function of what that person knows. I mean you could just roll out “I sold it at $95 oil and oil was $19 back in 1995 so lets go with a cost basis of 20% of what I sold it for” or whatever. An honest effort and paying taxes on 80% of sales cost. It doesn’t seem reasonable for the IRS to expect Joe Dude to give them a full economic reserve run from 1995. Just spitballing. And if you have to pay taxes, you are doing your part to buy another salvo of 155mm shells that will get fired into some empty field in the Donetz so take heart, all is not lost. 
If there has never been any production it must be in potash or part of a very large Fed lease.
That all sounds right, Mollyboy. I have attempted to research this matter, and it seems that IRS has not really provided much, if any, guidance. It appears there is no right answer on this, just what you think you can justify, if IRS questions your valuation.
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