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Timber rights are the ownership of the marketable trees on a particular property. Similarly – mineral rights (“mineral interest”) – are the ownership of the marketable minerals that are extracted from the land. Both are parts of an estate in real property. The complete private ownership is known as a “free simple estate”. The property owner may sell or transfer partial rights knowns as “surface rights” and “subsurface rights”. For tax
purposes – partial rights to a real property are treated the same was as a free simple estate – they may be sold, the seller will recognize a capital gain on the sale, etc.
The term "overriding royalty interests" means partial rights in the proceeds from the sale of minerals, produced from the land, which are usually limited in duration to the terms of an existing lease. That doesn't affect the treatment of the sale of mineral rights.
Let me know if you need any help.
Customer: Can you cite any tax documents or supporting documentation showing that the sale of mineral rights is capital gain, but the overriding royalties are ordinary income?
LEV: I would need some time to find references.
Customer: That is fine, I would really like some references.
LEV: See IRS publication 17 page 91 - www.irs.gov/pub/irs-pdf/p17.pdf
Sale of property interest. If you sell your complete interest in oil, gas, or mineral rights, the amount you receive is considered payment for the sale of section 1231 property
, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment on Schedule D (Form 1040).
For more information on selling section 1231 property, see page 28 in Publication 544 - http://www.irs.gov/pub/irs-pdf/p544.pdf .
If you retain a royalty, an overriding royalty, or a net profit interest in a mineral property for the life of the property, you have made a lease or a sublease, and any cash you receive for the assignment of other interests in the property is ordinary income subject to a depletion allowance.
Thus – if you retain the "overriding royalty interests" for the duration of an existing lease – not for the life of the property - that will not affect capital gain treatment.