Oil and Gas Royalty Deductions Guide for Tax Season

There are only a few better feelings than getting your oil and gas royalty check in the mail. Whether you have decided to lease your mineral rights or you have aided in an operation’s production, the extraction and sale of oil or gas earns you a nice bit of money each month.

Of course, all is fun and games until tax season. In this article, we will outline the most important things to know about oil and gas royalty deductions.

Depletion Allowances for Oil and Gas Royalties

Mineral rights are very valuable, that is until the resources have all been depleted. The IRS recognizes this and permits a depletion allowance on oil and gas royalty payments. Depletion allowances let property owners deduct the loss of value in the property’s subsurface, as well as any incurred expenses associated with owning the royalties.

Here, taxpayers can write off a portion of their income. Most commonly, people choose the standard 15% depletion deduction from the gross income. In other cases, heavily invested individuals can calculate the approximate remaining oil reserve and base their deduction on the amount extracted that tax year.

Royalty Deductions

Once your royalty checks start coming in, you may notice that there are some taxes that have been taken out of your payment. Although the amounts vary between states, most U.S. states take out a severance tax on the oil or gas production. This amount, as well as any other business taxes or fees associated with the production, can be deducted from your gross income.

Bonus Deductions

If you signed an oil and gas lease, then you may have received a nice upfront bonus payment. In the eyes of the IRS, this is considered ordinary income, in the rental property classification. Any bonus payment you receive, or any costs (like legal fees) associated with the lease negotiation, can be deducted on your Schedule E.

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