Mineral rights are subject to taxation at the county, state and federal levels. The taxes you must pay depend on whether your property is producing minerals.
At the state level, mineral rights are subject to a severance tax. The amount of state tax your mineral rights are subject to depends on the value of the minerals you produce.
Counties level a mineral tax that is similar to a property tax. Mineral interests are classified as real property and taxed based on the appraised "fair market value," defined as the price a buyer would be willing to pay to purchase the mineral interests on the open market. The county determines the appraised fair market value. This tax is collected only on producing mineral properties.
County Tax Assessment
Counties use a set appraisal method for determining the fair market value of a mineral interest.The goal is to provide all mineral rights owners a fair evaluation. If an owner does not agree with the appraisal, he is given the opportunity to protest.
At the federal level, royalty income from producing minerals is taxed as regular income. Therefore, the holder will pay tax according to her personal income tax category. Proceeds from royalty interests held less than a year are also taxed as ordinary income. If you hold property for more than a year, the IRS taxes earnings as long-term capital gains.
At the federal level, there are two ways you can reduce your tax burden. By using the depletion allowance, you can reduce the taxes paid on mineral rights. The depletion allowance compensates mineral-interest owners for the fact that mineral interests are non-renewable and eventually exhausted.
To take advantage of the depletion allowance, each year you deduct a portion of your original capital investment in the mineral property from the taxes you pay. The portion deducted must be equal to the fraction of the estimated remaining recoverable reserves that have been produced and sold that year, minus previous deductions.
In the event you sell your mineral interests, a "1031 exchange" allows you to defer paying capital gains tax. To use this tax deduction, the proceeds from the sale of the original property must be used to purchase a property of like kind. To capitalize on this benefit, you must abide by the deadlines set by the IRS. The IRS requires that you identify a new investment within 45 days, and close the purchase within 180 days.