Personal Finance: Ask the Experts

Get advice on money matters from The Bee's Claudia Buck and a panel of local experts

August 23, 2012
I own mineral rights; how are my oil and gas revenues taxed?

Q: I own mineral rights to land in North Dakota and have been leasing those rights to oil and natural gas prospectors for approximately seven years. In February of this year I began receiving disbursement checks for the oil and gas recovered from two wells. I would like to know how this money is taxed by the federal and CA state governments. Thank you for your assistance. -- Wayne Karlstad, Elk Grove, CA

A: Revenue from oil and gas leases usually consist of royalties or rents. Rent and royalty income is reported on page 1 of the federal Schedule E, Supplemental Income and Loss, of Form 1040. You should receive an information return, IRS Form 1099-MISC, from the payer if the payments exceed $600 reporting the amount and type of income by the end of January 2013 for calendar year 2012.

There may be deductions related to the rent or royalty income that you can deduct. One deduction specific to petroleum, mineral and timber related income is depletion. There are two ways to calculate depletion, the cost method and the percentage method. Cost depletion is based on the property's income tax basis, usually its cost, the number of recoverable units of oil or gas at the beginning of the year and the number of units sold of for which payment is received during the year. The percentage method calculates the deduction by applying specified percentage to the gross income from the property. The specific percentage for oil and gas is 15%. So if you were to receive $10,000 of royalty income, you would be entitled to a depletion deduction of $1,500 (15% times $10,000), based on the percentage method.

You can choose the higher of the deductions calculated by the cost method or the percentage method. You can use the percentage method one year and the cost method the next. Depletion deductions reduce the income tax basis of the related property, so you will have to keep track of them in order to correctly calculate gain or loss should you sell the property.

California taxes the worldwide income received by its residents. So you will have to report the rent or royalty income and related expenses to the state. North Dakota may also tax the income since it is from property located in that state. Check with the North Dakota Department of Revenue. If you do pay tax on the same income to both California and North Dakota, you may be entitled for a credit on your California return for the tax paid to North Dakota.

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Meet Our Financial Experts

Claudia Buck

Claudia Buck is The Sacramento Bee's personal finance columnist. Read all her columns here. Contact her at

Terri Carpenter

Terri Carpenter offers advice on job hunting, retraining and career counseling. Carpenter works at Sacramento Works Inc., the career and job training arm of the Sacramento Employment and Training Agency (SETA). With 15 years in the field, she has hands-on experience with everyone from first-time job seekers to career professionals seeking advice after a layoff or looking for a mid-career change. Ask her a question.

Carlena Tapella

Carlena Tapella is a partner in the law firm of Webb & Tapella Law Corp. in Sacramento. The firm specializes in estate planning and probate, such as estates, trusts, conservatorships and litigation. She is a past president of the Sacramento County Bar Association's Estate Planning & Probate Section. Ask her a question.

Kimberly Foss

Kimberly Foss, certified financial planner, is the founder of Empyrion Wealth Management in Roseville. With nearly 30 years in the financial industry, her clients include women in transition, small business owners, retirees and "pre-retirees." Ask her a question.

Jesse Weller

Gregory Burke, a CPA and tax expert with John Waddell & Co. in Sacramento since 1984, worked as an IRS tax auditor for six years. He’s a past chairman of the California Society of CPAs. Ask him a question.

Daniel Tahara

Daniel Tahara takes your questions about California taxes. Tahara, a spokesman for the state Franchise Tax Board, has 10 years of experience as a tax auditor. Ask him a question.

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