Posted on Feb 27, 2017

The oil and gas industry has experienced booms and busts of varying lengths since the dawn of mineral exploration. The current climate for O&G suggests continued consolidation, however forecasts by industry experts anticipate the boom may be back by 2018. For any owners or buyers of mineral interests, the market may be ripe for making deals now — with a careful eye toward the tax implications of buying and selling mineral rights. No two deals are alike, and it’s important to learn the potential tax impact and the types of taxes you may be paying.

Hold ‘em or fold ‘em? It’s not a poker game. It’s the oil and gas industry.

The U.S. oil and gas industry overall may still be in a consolidation phase, but reports from industry watchers like Deloitte noted in fall 2016 that activity may pick up briskly as early as 2018. In Texas, however, the environment looks different, with more hiring and production activity in early 2017 than was seen over the last two years.

Anticipating the shift, corporate E&P activity to build up reserves has been happening in West Texas since 2015 with multi-million dollar deals in the Permian Basin and elsewhere. According to Reuters, more than $28 billion in land acquisitions were transacted in West Texas last year, more than triple those in 2015. The players include Exxon and newer E&P players like Parsley Energy.

We are familiar with the variety of scenarios in oil and gas transactions. Each deal is unique, but there are a few common scenarios worth reviewing that demonstrate how the tax law treats transactions differently. Whether you are selling, leasing or buying, now is a good time to consider your options and prepare to act at just the right time.

Following are common scenarios that can occur in oil and gas transactions and their various tax treatments.  Before we introduce these scenarios, it is important to understand the types of ownership interests commonly seen in the oil and gas industry and the differences between them.

  • Royalty interests and over-riding royalties both collect a specified percentage of the gross revenue from the sale of oil and gas produced. Both typically are subject to severance tax that the State levies on oil and gas production. Both may also be subject to the costs of delivering the product to market (i.e. pipeline services fees), but royalty interests are normally not charged with the cost of developing the property nor are they normally charged with the cost of production and maintaining the well.
  • Net profits interests are a hybrid royalty that typically does not receive payment until the working interest owners have realized a pre-determined profit.
  • Working interests collect a specified percentage of revenue and pay their proportionate share of severance tax and the costs of delivering the product to market. However they are responsible for 100% costs of operating the well, producing the oil and gas, drilling and developing the well and maintaining the property. Clearly, the working interest owner takes virtually all of the risk in a very risky business. The tax law does provide the working interest owner with some unusual tax benefits, but those are beyond the scope of this article.

Oil and Gas Transaction Scenarios

The following scenarios are not based on any actual past or present oil and gas transaction, and the information provided does not constitute tax advice. These examples were created to more easily demonstrate the complexity and nuance of taxable or nontaxable mineral interests. Before entering into any contract, consult with your CPA or attorney. Click on any of the scenarios below to learn more about the scenario specific tax implications of buying and selling mineral rights.

SCENARIO #1 – Leasing vs. Selling Mineral Rights

SCENARIO #2 – Land Owner vs. Mineral Rights Owner

SCENARIO #3 – Lessee vs. Developer

SCENARIO #4 – Sale of Proved Up vs. Undeveloped Interests


Buyer and Seller Beware

Before leasing, buying or selling mineral rights or access, players must consider the current market. Market fluctuations impact the value of the property and also the options for structuring a successful transaction. The next few years may prove very fruitful for oil and gas in Texas or show mixed results because of global market pricing pressure, the political environment or other factors.

Cornwell Jackson’s Tax team can provide guidance on the structure of land and mineral rights transactions in line with market cycles and your goals. Our team can discuss the merits of certain deals and tax treatments both short-term and long-term. Contact us with your questions.

Download Now: Oil & Gas Update: Tax Implications of Buying and Selling Mineral Rights

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients. Contact him at or 972-202-8032.