Setting the Basis - Establishing a Basis for an Inherited Mineral Interest
February 12, 2019
What is the “Mineral Basis”?
We get lots of calls from people who need to establish a basis for the mineral interest that they inherited from a relative. According to the IRS, your basis of the property you inherited from a decedent is generally the fair market value (FMV) of the property at the date of the individual's death. Even if a federal estate tax return doesn’t have to be filed, your basis in the inherited property is its appraised value at the date of death for tax purposes.
Looking Back to Determine the Basis.
In many cases, there can be a significant time lapse between inheriting the interest and selling it. The time lapse can make a FMV basis appraisal somewhat more difficult because the appraiser needs to consider the property at the time of transfer. This requires research about what was known or knowable at the time the minerals were inherited by you. Using ex-post information, information that is known after the effective date, is generally not applicable because the general market did not have the benefit of that information. This is particularly true when major market swings have occurred after the fact that could not have been reasonably predicted on the effective date such as major oil price increases or decreases.
How do We Determine the Mineral Basis?
An appraisal to set the basis on inherited minerals would typically use the following approaches to determine FMV:
For properties that are leased and generating income – A discounted cash flow or sometimes a multiple of cash flow can be used to determine FMV. When the income on the inheritance date is from “old and tired” wells, the appraisal may include an evaluation of prospective plays that were known or knowable on that date. It may be possible to assign additional value based on income to be obtained in the reasonably near future. In some situations, the cash flow is not representative of the value of the minerals and comparable sales are evaluated.
Properties that are leased and are not generating income - Landmen seek properties that are unleased and lease them from the mineral owner betting that eventually the minerals will be developed. A lease is usually signed with a lease bonus. A lease bonus is paid upon signing the lease and is typically a dollar amount per net mineral acre. This pricing information can be supplemented with data from comparable sales, which is the price paid for similarly situated properties at or near the time of the inheritance. The older the date of inheritance the more difficult it is to find the parties to the transaction and we rely on their memories, if no copies of sale information are available.
Properties that are not leased and are not generating income are difficult to value and sometimes appear to have no value. Minerals that have no market demand are basically without value. Unleased minerals typically rely on comparable transactions for minerals. This requires a search of mineral deeds in the vicinity of the subject minerals. If no similar transactions can be found or if there are no transactions whatsoever, any value assigned to the minerals would be arbitrary. If similar transactions are found, the appraiser would have to adjust the comparable sales based on any number of factors such as acres, distance to nearest production, geologic properties, and market trends.
See here for more information from the IRS: https://www.irs.gov/publications/p551
Call us today for help with setting the basis for your minerals.
These materials have been prepared solely for educational purposes to contribute to the understanding of oil and gas appraisal. These materials reflect only general concepts in the industry based on Colorado and may not apply to all circumstances. It is understood that each case is fact ‐ specific, and that the appropriate solution in any case will vary. These materials may not be relevant or apply to any particular situation. While every attempt was made to ensure that these materials are accurate, errors or omissions may be contained therein, for which any liability is disclaimed.