Friday April 26, 2024

4.7.7 Oil, Gas and Mineral Interests

Oil, Gas and Mineral Interests

Shale Mega-Gifts:  As the cost of all energy has increased, America is in the fortunate position that within a decade it has the potential to become energy independent.

Ownership of Minerals:  There are several potential types of ownership that affect mineral interests. The owner of surface rights with a fee interest also has the ownership of all of the subsurface minerals.

Leasing the Property:   In many cases, an owner owns both the surface and the mineral interests. The surface may be used for farming or ranching purposes.

Joe and Mary Minerals:   Assume that Joe and Mary Minerals are both age 65. They currently live in Atlanta, but Mary grew up near Watford City, North Dakota.

Maintenance, Insurance and Taxes Agreement:   THIS AGREEMENT is entered into at ____________County, State of _______________, on ________________, by and between _____________________, a qualified exempt Section 501(c)(3) charity (the "Charity")...

MIT Agreement Minerals Provision:   The standard allocation is 75% of all payments after the date of the deed to the life income recipient and 25% to the charitable remainder beneficiary.

Personal Foundation:   After the unitrust has been funded, it is permissible to use the trust corpus to make a current gift.

Valuation of UT Income Interest:   Unitrust income and remainder interests are valued using the methods of Reg. 1.170A-7(a) and IRS Publication 1458.

Gift Tax Deduction:   The transfer of the income interest also will qualify for a gift tax deduction.

Gift of Excess Principal:   With the expected rapid growth of the unitrust, Joe and Mary may make major gifts to charity.

Appreciated Property Gift Deduction:   Unitrusts are subject to the four-tier rules of Reg. 1.664-3(a). The trust must record the amount of ordinary income, capital gain, tax-free income and principal.

Specimen Unitrust Income Interest Gift Language:   Dear Trustee:

I am currently the income recipient of a one life charitable remainder unitrust that was created on July 4, 2005 with trust grantor George Washington, 123 Main Street, Anytown, Illinois 00000 and initial trustee Charitable Organization, 456 Main Street, Anytown, Illinois 00000.

Unrelated Business Taxable Income:   One of the key concerns for charities and charitable trusts is that there not be unrelated business taxable income under Sec. 512(b)(2).

Triple Tax Benefit:   The Personal Foundation completes a triple tax benefit for Joe and Mary. First, they are able to accumulate tax-free in the unitrust most of the royalty payments.

Major Planned Gift Opportunity:   With the dramatic growth in oil and gas production in the nation, there are thousands of current donors to charity who hold mineral interests.

Mineral Interest Checklist:   Legal description of mineral interest:

How is interest owned (e.g., individually, jointly, partnership, corporation)?

Shale Mega-Gifts


As the cost of all energy has increased, America is in the fortunate position that within a decade it has the potential to become energy independent.

During the past three decades, the nation has imported billions of barrels of oil, largely from Canada, Mexico and the Middle East. However, the development of shale production technology through advances in horizontal well drilling has opened up major new production throughout the nation. Among the very large shale deposits are the Bakken Shale deposit in North Dakota, the Eagle Ford and Barnett Formations in Texas, the Marcellus in Pennsylvania and the surrounding states and at least 20 other formations throughout the nation.

These discoveries and new production techniques have dramatically increased oil and gas production. The monthly oil production in North Dakota during the past five years has increased from 4 million to 20 million barrels per month. In Pennsylvania, the horizontal drilling methods have led to a sevenfold increase in gas production during the past five years.

Ownership of Minerals


There are several potential types of ownership that affect mineral interests. The owner of surface rights with a fee interest also has the ownership of all of the subsurface minerals. This could include oil, gas, coal, precious stones, gold, silver and other types of minerals. The owner has the right to exploit, mine and produce any or all of the minerals. The typical benefit to the owner is through royalty payments that are a percentage of the production.

Because the production of the minerals can be quite complex, the owner will typically lease the right to extract minerals to an operator. The operator normally will drill for oil and gas or use appropriate methods for extracting other types of minerals. The operator generally follows a Joint Operating Agreement (JOA).

Both the mineral owner rights to royalties and the operator working interests may be divided. The mineral owner may transfer a portion of the royalty interest to another person. If the owner desires to retain all of the executive powers and to retain lease and bonus payments, the transferred interest will be a non-participating royalty interest (NPRI). This transfer is frequently done within family groups to provide other members with royalty interests, but not any management or executive responsibilities.

Similarly, an operator may create an override royalty. From the profits of a producing oil or gas well, the override royalty may typically be 3% to 5% of the production.

Leasing the Property


In many cases, an owner owns both the surface and the mineral interests. The surface may be used for farming or ranching purposes. In addition, the farmer or rancher then may lease the property to an operator who will plan to drill for oil or gas.

The usual compensation to the landowner includes a bonus payment for a typical three year lease, a royalty payment if minerals are produced and a delay rental payment to extend the lease if production has not been achieved by the end of the stated term.

The largest payments usually are the lease bonus amount and the royalty. The royalty amounts for the owners are typically a 1/8, 3/16 or a quarter of the value of the minerals extracted. The owner refers to his or her royalty amount as 12½%, 18 ¾% or 25% for these fractional payments.

Joe and Mary Minerals


Assume that Joe and Mary Minerals are both age 65. They currently live in Atlanta, but Mary grew up near Watford City, North Dakota. She has inherited a portion of the family ranch and owns 100 acres near Watford City. This property is not yet under production, but the surrounding ranches are all part of the Bakken Shale formation. She has been approached numerous times about leasing the property and placing it into production.

The value when she inherited the land was $100,000 because the Bakken production was not yet active. However, the appraised value of the property is now $1 million. This appraised value reflects the highly probable oil production because it is in the center of the Bakken Shale formation.

Joe and Mary are both board members of Atlanta area charities. They would like to consider the full range of potential charitable gift strategies.

Example 1 – Lifetime Gift of Land


If Joe and Mary transferred the surface but retained the minerals, there would be no charitable deduction. The transfer of just the land would be a partial interest in property. Gifts of partial interests generally are not deductible. Sec. 170(f)(3)(A).

A gift of an undivided percentage of the entire property that included both the surface and the minerals would be permitted. Sec. 170(f)(3)(B). Therefore, if Joe and Mary decided to make a gift of 50% of the property, they could qualify for an appreciated property deduction of $500,000.

As is true with all appreciated property gifts with a value of more than $5,000, they would need to obtain an appraisal by a qualified appraiser. The appraiser must hold himself or herself out to the public as an appraiser and must fulfill all of the appraisal requirements. The document must state that the appraisal is completed for income tax purposes, show a description of the methods of the appraisal, describe the comparables used for the appraisal, list the appraiser's qualifications, include a description of the property and provide other required information.

With a qualified appraisal and a signature by the appraiser and the recipient charity on IRS Form 8283, Joe and Mary could have appropriate substantiation of their charitable deduction. Because the deduction is 50% of the property, it is less likely that there will be a reduction for lack of marketability for minority interest. In addition, because the Bakken formation covers a large portion of North Dakota and Montana, it is relatively easy to locate an appraiser with the appropriate credentials in valuing mineral interests.


Example 2 – Gift of Mineral Interest or Royalties


The primary value of the 100 acres is the potential for oil and gas production. If Joe and Mary were to retain the surface rights and give the mineral interests outright to favorite charity, once again there would be no deduction under Sec. 170(f)(3)(A). A land owner who has the "fee interest" is deemed to own all of the surface and subsurface rights. A gift of part of the bundle of rights is a nondeductible partial interest.

In some circumstances, Joe and Mary Minerals may previously have leased the property and be receiving royalties. There are two options for gifts with royalties. First, they could receive the royalties into their taxable income and then write a check to the charity in order to receive a charitable deduction. A gift of cash is deductible up to 60% of adjusted gross income.

However, there are multiple negatives for that plan because Joe and Mary have a very large income of approximately $400,000 per year. Increasing their income will subject them to the maximum 37% income tax rate, the 3.8% Affordable Care Act tax and the phase-out of the alternative minimum tax exemption. Therefore, Joe and Mary may prefer simply to allow the income to be transferred to favorite charity. This plan could avoid pushing them substantially over the $450,000 per year income level where all of the negative income tax impact occurs.

If Joe and Mary decided to transfer a term royalty, they would in effect give two or more future years of income to the charity. Because the charity would be vested with the right to receive the income that flows from a capital asset rather than personal employment, Joe and Mary would not be taxed on the income. The income simply would be directed to the charity. This is a much better result for Joe and Mary than receiving the income and experiencing a very high level of adjusted gross income that creates multiple additional taxes. The royalty deed for a term of years simplifies their tax picture and will save income tax.


Example 3 – Life Estate


If Joe and Mary desire to retain the property for their lifetimes, they may consider the transfer of a life estate. Because the land is valued at $1 million and there are no buildings, the charitable deduction is the present value of the future gifts to charity. A personal residence or land used for agriculture purposes will qualify for the life estate deduction. This is an exception to the Sec. 170(f)(3)(B) partial interest rules.

Joe and Mary can deed the remainder interest to favorite charity and retain the life use. Retaining the life use then enables them to receive the rentals and most of the royalties from the property. The charitable deduction for Joe and Mary is $643,190. Because this is an appreciated type charitable deduction, it is usable up to 30% of their adjusted gross income. With $400,000 of income each year, their deduction limit for this type of gift is $120,000 per year. The deduction will reduce taxes over a period of five to six years.

Joe and Mary receive a fairly modest rent for leasing the surface to a neighboring cattle rancher. However, the major portion of the income interest will be royalty payments from oil and gas extracted from the Bakken Shale formation.

Joe and Mary sign a "Maintenance, Insurance and Taxes (MIT)" agreement that clarifies the relationship they have with the charity that will receive the 100 acres. The agreement indicates that as the life tenant, Joe and Mary will be responsible for doing the maintenance on the property, insuring the property to cover any potential risks both to themselves and to the remainder charity and paying the property taxes.

There also is a provision to address the potential for oil and gas production. Because the oil and gas production will "deplete" to some extent the mineral interests, there must be a shared payment of this amount. While the life tenant will usually receive all rental amounts, the use of the land for grazing purposes will not deplete any of the charitable remainder property. However, extraction of the Bakken oil and gas will result in less value for the remainder recipient.

Because the IRS charitable gift rules are designed to respect the property interests of both the life tenant and the remainder recipient, it will be necessary to have an agreement with respect to the minerals. State law may establish different rules in the absence of an agreement, but it is normally acceptable in any state for the life tenant and charitable remainder beneficiary to create an allocation formula.

In Rev. Rul. 90-103, 1990-2 C.B. 159, the IRS addressed the issue of a pooled income fund that could potentially hold depreciable or depletable interests. In this ruling, the IRS stated that a pooled income fund governing instrument must include provisions for a depreciation or depletion reserve under generally accepted accounting principles (GAAP). If the pooled income fund agreement did not exclude the potential for depreciable or depletable assets, then the document "must provide for the creation of a depreciation reserve pursuant to GAAP." Therefore, if there are depletable assets such as oil and gas, the governing document must require the creation of a depletion reserve. See also Rev. Rul. 92-81

Similarly, with a life estate, the extraction of the minerals has potential impact on the charitable remainder recipient. Therefore, the MIT Agreement includes a section that covers mineral interests. Below is a specimen MIT Agreement that includes provisions to cover mineral interest allocation between the life tenants and the charitable remainder beneficiary.


Maintenance, Insurance and Taxes Agreement


THIS AGREEMENT is entered into at ____________County, State of _______________, on ________________, by and between _____________________, a qualified exempt Section 501(c)(3) charity (the "Charity"), and _________________ and ___________________, husband and wife, of ____________, _______________ (the "Donors"). WHEREAS, the Donors have this day executed a deed giving to the above charity a remainder interest in their personal residence in the City of ____________ and County of ____________, or their agricultural land in the County of ___________, known as ________________________ _______________ (the "Property").

NOW THEREFORE, the parties hereto agree as follows:

1. The Donors, jointly and severally, shall have the sole responsibility for maintaining the property, insuring the property against loss and liability, and paying real estate taxes, and shall not, without the consent of the Charity, permit any lien or mortgage to be placed on the property other than liens or mortgages which may now exist, and shall not, without the consent of the Charity, permit the amount of any lien or mortgage now existing to increase.

2. The Donors shall, during their respective lifetimes, have the sole right to occupy and utilize the premises as their residence or for agricultural purposes, and may lease the premises to any other person for use as a personal residence or for use of agricultural land. The Charity shall join in any lease of the premises to another in order to permit the lease term to continue beyond the death of the surviving Donor, provided that such term shall not continue for more than one year beyond the date of death of the surviving Donor and provided further that the Charity shall be entitled to the rent from the property from the date of death of the surviving Donor.

3. If there are mineral interests in, on or under the property, then after the date of this agreement, any lease bonus payments, lease amounts, delayed rental amounts, royalties or other payments shall be allocated between the life tenancy and the charitable remainder beneficiary. Under Generally Accepted Accounting Principles and based upon (i) All available evidence, (ii) The best available marketplace assumptions, (iii) The remaining estimated useful life of the mineral interests, (iv) Any potential future capital expenditures, and (v) A range of cash outflows and inflows based upon multiple scenarios, the parties agree that all mineral interest payments shall be divided with 75% distributed to the life tenants and 25% to the charitable remainder beneficiary.

4. In the event of any damage to the property, the Donors, at their sole expense, shall cause such damage to be repaired unless the Donors and the Charity shall agree that it is impractical to do so, in which case, any insurance proceeds resulting from such damage shall be divided between the Charity and the Donors in accordance with the value of their respective interests as of the date such damage occurred. For purposes of determining the value of the Charity's interest in the event of such loss, the value shall be determined in the same manner as is used to value a remainder interest in a personal residence as is provided in U.S. Treasury Regulations Section 1.170.

5. The Donors, jointly and severally, agree to hold the Charity harmless against any and all liability arising from the property during their lifetimes. The Donors may at any time or times at their sole expense make improvements to the property, provided that such improvements shall not result in a reduction of the value of the property.

IN WITNESS WHEREOF, the parties hereto have set their hands and seals the day and year first above written.

THE CHARITY

DONORS

By: ___________________________

____________________________

And by: ________________________

____________________________


MIT Agreement Minerals Provision


The standard allocation is 75% of all payments after the date of the deed to the life income recipient and 25% to the charitable remainder beneficiary. Because estimating the value of minerals is extremely complex and subject to a large number of difficult-to-determine variables, it is probably best to use this approximation as a fair representation of value for both parties. However, for a very senior person, the percentage for the remainder recipient would be higher. Similarly, for younger individuals, the percentage to the remainder recipient may be a lower amount.

With the life estate gift, once again it will be necessary to obtain a valuation by a qualified oil and gas appraiser. The appraiser may consider the percentage allocation of mineral royalties between the life tenancy and the remainder beneficiary as one factor in this appraisal.

Example 4 - Charitable Remainder Trust


An excellent income-tax-saving strategy for Joe and Mary is a charitable remainder unitrust. Because the royalties represent very substantial amounts of ordinary income and tax rates on upper income persons in many states now are approaching 50%, there is a very strong incentive to find methods to accumulate ordinary income tax-free. A 5% unitrust is a superb method for achieving that result with oil and gas properties.

Joe and Mary transfer the entire property (both surface rights and minerals) into a 5% FLIP unitrust. A FLIP unitrust starts as a net income plus makeup trust. After the trigger event, the trust converts to a standard unitrust the following January 1.

With real estate that holds mineral interests, there should be an "earlier of property sale or production of minerals" trigger event. Because this property is intended to be held to produce royalty income, the FLIP trigger event is the production of oil and gas above a stated baseline. After the property is producing royalties, the next January 1 is the FLIP date. It is best to use a standard unitrust for the period after commencement of oil and gas production.

Because the oil and gas interests will produce ordinary income far above 5% and the trustee desires to avoid the issue of creating a depletion reserve, a standard unitrust is the preferred option. In addition, Joe and Mary plan to use the unitrust as a "personal foundation." The use of a standard unitrust will facilitate obtaining an appropriate charitable deduction for the gifts they plan to make at the end of each year from the unitrust. With the rapid growth of the unitrust in the early production years, they contemplate making major cash gifts.

The unitrust income in the early years is expected to be primarily the royalty amounts. Because the valuation of mineral interests is quite often three to four times the payout, the initial years for production produce income of 20% to 25% of fair market value. However, the illustration must also reflect the substantial decline in production amounts that is typical with the hydraulic fracturing production method. Production is extremely high for the first year or two. However, because the continued production is dependent on obtaining oil from the subsurface rock more distant from the horizontal drilling, production declines substantially in future years.

Therefore, the assumed return declines substantially over a period of 20 years. The return starts at 25%, then 20%, then 16%, 14% for five years, 13% for four years, 12% for three years, 11% for three years and 10% for three years. The return finally is reduced to 6% ordinary income and 2% growth for the duration of the trust. Because Joe and Mary are both age 65, the two life unitrust is estimated to last for 26.2 years.

The benefit of the 5% trust is that a very substantial portion of the royalty payments are accumulated tax-free in the trust. This has a double benefit for Joe and Mary. They are not subjected to the extremely high tax rates and phase-outs of various exemptions under the American Taxpayer Relief Act. In addition, they will benefit from the receipt of increased income from the accumulations in the trust during their lifetime. The trust produces an income tax deduction of $338,100 the first year. There also is an avoidance of tax on the $900,000 of gain that may save $180,000. While the property is held by the trustee rather than selling the property, in essence the oil royalties are a substitute for the gain that would be recognized on the sale of the property. By accumulating the oil royalties in the trust, the actual savings are far greater than the $180,000. Cumulative income tax savings over the life of the trust could easily approach $1 million.

The trust is initially funded with the $1 million asset, but grows quite rapidly in the early years with the high oil production. The trust increases over the 26 years from $1 million to $9,051,123.

The distributed income starts at 5% or $50,000. Because the trust grows rapidly, income paid to Joe and Mary during their more senior years increases to $300,000 to $400,000 per year. Because this trust has very large ordinary income amounts, the trust is likely to pay ordinary income character for the two lifetimes. However, even though the trust pays ordinary income, the tax-free accumulation of several million dollars of ordinary income is a very large benefit to Joe and Mary.

This charitable trust will also require the initial appraisal in a manner similar to the other charitable agreements. In addition, it will be necessary to have a valuation each year to determine the appropriate payout amounts. Because this valuation does not need to meet the same standards for a charitable deduction, it is expected that the annual valuation by a special trustee who is designated for that purpose should be considerably less expensive. The initial appraisal involves mineral interests and therefore could easily be $5,000 to $8,000. It is expected that the annual valuation is merely an update of that appraisal and should be accomplished for 20% to 35% of the initial cost.

Personal Foundation


After the unitrust has been funded, it is permissible to use the trust corpus to make a current gift. The trust document signed by Joe and Mary permits gifts of a percentage of the income interest at the end of each year. Under state law, the donor has previously made an irrevocable gift of the remainder interest but has retained the income interest. If the donor then transfers part or all of an income interest to a vested remainder recipient, the charity then owns the remainder and the income interest. Under the doctrine of merger, the charity then owns the entire interest in that portion and a distribution of principal may then be made to the charity. If Joe and Mary transfer part of their income interest to charity, there is a charitable deduction for a gift of that portion of the trust. Reg. 1.170A-7(a)(2)(i).

Valuation of UT Income Interest


Unitrust income and remainder interests are valued using the methods of Reg. 1.170A-7(a) and IRS Publication 1458. Based upon the age or ages of the income recipients on the date of the income interest gift, the applicable federal rate, the frequency of payment, the unitrust corpus value and the unitrust percentage, the present value of the income interest may be determined. If the entire unitrust income is transferred to charity, then the amount calculated using the Treasury method is usually the deduction value. With a standard unitrust, the value of the income interest is based on the stated payout percentage.

Gift Tax Deduction


The transfer of the income interest also will qualify for a gift tax deduction. So long as the donor gives an undivided percentage of his or her entire interest, the charitable gift tax deduction will qualify. Reg. 25.2522(c)-3(c).

Gift of Excess Principal


With the expected rapid growth of the unitrust, Joe and Mary may make major gifts to charity. It should be possible for donors to make occasional gifts from a charitable trust to a charity, so long as the amounts and timing of the gift are determined well after the trust is created. For many donors, a gifting strategy would be to give the excess growth to a charity. As the trust corpus grows, those donors who do not need the added income may choose to give the growth to charity. In many respects, the unitrust may function as a very low-cost alternative to the private foundation. This may be called the "Personal Foundation" for Joe and Mary.

Appreciated Property Gift Deduction


Unitrusts are subject to the four-tier rules of Reg. 1.664-3(a). The trust must record the amount of ordinary income, capital gain, tax-free income and principal. Payouts to income recipients must fully exhaust each category before the next tier is distributable. Because royalties are ordinary income, all payouts to Joe and Mary will have the character of ordinary income.

However, growth of the unitrust will produce a substantial capital gain within the trust. Under Reg. 1.664-3(a)(4), the governing instrument may provide that any amount (other than the unitrust amount) may be paid to an organization described in Sec. 170(c). The attorney for Joe and Mary included this provision in their trust document.

With respect to the trust, no gain or loss is realized due to the discretionary in-kind distribution under Reg. 1.664-1(e)(2). However, the trustee must still determine the character of the distribution. Reg. 1.664-1(e)(1) mandates the use of a reverse four-tier accounting system. Specifically, the distribution will be considered to come first from corpus; second from other income; third from capital gains; and finally from ordinary income. Therefore, the gifts each year will be zero-basis, appreciated-type gifts. They will be deductible at the full value of the gifted income interest with a 30% of adjusted gross income limit.

Specimen Unitrust Income Interest Gift Language


Trustee
Organization
Address
City, State Zip Code

Re: Charitable Remainder Unitrust ______________


Dear Trustee:

I am currently the income recipient of a one life charitable remainder unitrust that was created on July 4, 2005 with trust grantor George Washington, 123 Main Street, Anytown, Illinois 00000 and initial trustee Charitable Organization, 456 Main Street, Anytown, Illinois 00000. The unitrust federal ID number is __________________.

As life income recipient, I have retained the power under section ________________ of that trust document to add, remove or modify by name or percentage the qualified exempt charitable remainder recipients. I declare my intention through this signed and dated writing to modify the charitable remainder recipients by irrevocably designating a percentage of both income and remainder interests to a qualified exempt charity and retaining the balance of the income interest and the right to modify the charitable remainder recipients for the balance of the trust.

In order to make a charitable gift of part of this charitable remainder unitrust, I hereby irrevocably designate qualified exempt charity ____________________________, of City, State, as the recipient of _____% of both the income and remainder interests in unitrust number _________________.

The trustee is authorized to recognize that under the doctrine of merger of income and remainder interests, the named exempt charity now owns all interests in the specified percentage of this remainder unitrust. Therefore, the trustee may distribute that portion of the trust principal to the named exempt charity.

I understand that this transfer to a charitable organization may qualify under IRC Sec. 170 provisions for a charitable income tax deduction for the present value of the gifted income interest.

Sincerely yours,


____________________________ Date: ____________
Unitrust Income Recipient

Unrelated Business Taxable Income


One of the key concerns for charities and charitable trusts is that there not be unrelated business taxable income under Sec. 512(b)(2). Fortunately, royalty interests are deemed passive interests and do not create UBIT. Rev. Rule. 69-179; PLR 7741004. However, a working interest is normally held by the company that actually drills and extracts the oil. Understandably, this is a very active business and holding a working interest would produce UBIT. Even with a working interest, it is possible to create an override royalty interest. The override royalty is also a passive interest that does not produce UBIT.

Therefore, the charity that receives an outright gift of the mineral interest and benefits from royalties, a charity that receives a remainder interest in a life estate and receives 25% of the royalties, and a charitable remainder unitrust that receives a portion of the royalties are all excluded from unrelated business taxable income.

Triple Tax Benefit



The Personal Foundation completes a triple tax benefit for Joe and Mary. First, they are able to accumulate tax-free in the unitrust most of the royalty payments. Second, they reduce their adjusted gross income and avoid many of the highly- punitive provisions of the American Taxpayer Relief Act. Third, because of the reverse four-tier rules, they can give the capital gain portion of their unitrust at the end of each year and benefit from a 30%-type charitable deduction. Fourth, they have an excellent method for making lifetime gifts to their favorite charities. These distributions of unitrust principle could fund scholarships or other designated gifts.

Major Planned Gift Opportunity


With the dramatic growth in oil and gas production in the nation, there are thousands of current donors to charity who hold mineral interests. While the various interests can be fairly complex and it is important for charities to have access to attorneys who are familiar with the ownership of mineral interests, this is a wonderful planned gift opportunity for charities nationwide.

Mineral Interest Checklist


Legal description of mineral interest:

How is interest owned (e.g., individually, jointly, partnership, corporation)?

Mineral Interest:
1. How much is owned (percentage or decimal)? _______________________

2. Is the interest leased? Yes___ No___

a. Is copy of lease attached? _____

3. Is there surface use? Yes___ No___ . Type Use? _______________

4. Currently in production? Yes___ No___

a. Royalty Percentage _____________

b. Approximate yearly income _____________

5. Copy of deed or document creating interest? Yes___ No___

6. Title history? Yes___ No___

Royalty Interest or Override Royalty Interest:

1. Oil and gas only? Yes___ No___: if not, then what?________________________

2. How much is owned (percentage or decimal)?_____________________________

3. Currently in production? Yes___ No___

a. Copy of division order ____ b. Approximate yearly income _____

4. Is the interest non-participating? Yes___ No___

a. Copy of Joint Operating Agreement if overriding royalty interest ____

5. Copy of document creating interest? Yes___ No___

6. Title history? Yes___ No___

Gift planning options:

1. What type of gift is being considered (e.g., outright, trust, other)? _____________

2. Is a tax deduction sought? Yes___ No___

3. Cost basis____________________

If charitable organization will retain and manage a leased interest:

1. Operator Name, City, State: _______________________, _________________

2. Payor(s) Name, City, State: _________________________, ____________________

3. Owner (donor) Identification Number (see division order): ______________________

4. Lease Number (see division order): _________________________

5. Property Plat Map? Yes___ No___

6. Unit Designation Map? Yes___ No___

7. Mineral Owner Report? Yes___ No___

Case Studies on Oil, Gas and Mineral Interests

Lucky Lucy Lindstrom's Unitrust :   Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy realized that "shorting" financial stocks was going to be a bonanza. She was so successful in the down market that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and has learned that giving a helping hand to someone in need is even more gratifying than making another million in the futures market. After reading in a charity's weekly enewsletter about a charitable remainder trust, Lucy called Clara Johnson, a gift planner at her favorite charity.

Lucy suggested that she would transfer $5,000,000 of securities to a 5% net plus makeup unitrust (NIMCRUT). She would serve as trustee, make the investments and the charity would be the remainder recipient. Since Lucy normally earns 18% per year on her futures and commodities investments, she feels that it would be easy to make the unitrust grow to $10,000,000 or more.

Would this plan work? May Lucy serve as trustee? Is it permissible to invest unitrust assets in the futures market?
Lucky Lucy Lindstrom's Long Shot Unitrust:   Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and has learned that giving a helping hand to someone in need is even more gratifying than making another million in the futures market. After reading in a charity's weekly enewsletter about a charitable remainder trust, Lucy called Clara Johnson, the gift planner for her favorite charity.

Lucy recently invested $1,000,000 in stock in a Canadian oil "wildcatter" with the name Northern Long Shot, Inc. This company has been drilling new exploratory wells in the far north. Recently, its stock rose from the $1 per share that Lucy paid to over $3 per share. Lucy thinks that the stock could move much higher next year, but she would like a charitable deduction this year. She asked Clara if she could use the stock to fund a unitrust, serve as trustee and hold the stock for another two years.

Would this plan work? May Lucy serve as trustee? Is it permissible to hold the highly speculative stock in the unitrust?
Lucky Lucy Lindstrom's Flood Recovery Plan:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio. Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and has learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market. After reading in her favorite charity's weekly enewsletter about the need for housing in a low-income area that had been destroyed by a flood, Lucy called Clara Johnson, the charity's gift planner.

Lucy had invested $1,000,000 in stock in a renewable energy company with the name Northern Long Shot, Inc. This company designs and manufactures energy solutions for companies across the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy thinks that this stock should be sold as soon as possible, but she would like to receive a deduction this year. In addition, she thought that the $5,000,000 could be placed in a private foundation to make loans to low-income individuals who otherwise could not afford to rebuild their homes. Since she wanted to have direct influence over the program, Lucy called her attorney Susan White to discuss a potential major gift to a private foundation for low-income housing loans.

Would this plan work? Can the private foundation receive the gift and sell the Northern Long Shot, Inc. stock? May the funds be used to offer housing loans to low-income individuals? Is there a better plan?
Lucky Lucy Lindstrom's "Cousins' Scholarship" Plan:   Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and has learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in a "penny stock" company. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy thinks that this stock should be sold as soon as possible, but she would like to receive a charitable deduction this year. In addition, she thought that the $5,000,000 could be placed in a supporting organization with a community foundation to provide scholarships for students.

Lucy comes from a large family. She has 30 cousins, and many of their children are now entering college. Since her supporting organization will distribute $250,000 in scholarships each year, Lucy asked the community foundation's CEO if she could give scholarships to the children of her 30 cousins. She likes the concept of a "Cousins' Scholarship" program.

Would this plan work? Can the supporting organization fund scholarships for her cousins' children?
Lucky Lucy Lindstrom's "Personal Loan" Charity:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucky Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a "penny stock" company. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy was delighted with her gain and decided to give the $5,000,000 to a supporting organization (SO) of her favorite charity.

For the first two years, the SO distributed grants for charitable purposes. However, in year three, Lucy made a major mistake in her personal commodities investing. She now wants to borrow $3,000,000 from the SO to "tide her over" through this difficult time. Since she needs all her assets to cover her leveraged obligations, Lucy would like to obtain a no-interest loan for two years from the SO. After all, she thinks, "I gave $5,000,000 to the SO, so it surely would be okay to borrow $3,000,000 at no interest for two years."
Lucky Lucy Lindstrom's "Wheeler-Dealer Charity LLC":   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor and began advising clients.

Lucky Lucy Lindstrom's "Ultimate Control" Charity :   Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market. Lucy invested $1,000,000 in a "penny stock" company. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy was delighted with her gain and decided to give the $5,000,000 in stock to a charitable foundation to help those in need.

Lucy discussed several options with her attorney and her favorite charity. She could create a private foundation (PF), or she could set up a supporting organization (SO) with her favorite charity. If the supporting organization were created, her favorite charity wants to elect three of the five directors, and Lucy would elect two directors. Since the SO would be controlled by her favorite charity, it would also qualify as a public charity. Lucy could give the stock and take a deduction up to 30% of her adjusted gross income, with a five-year carry-forward for the excess value.

Lucy thought about the SO but was also very interested in a private foundation (PF). She asked her attorney for reasons to select one or the other. Her attorney noted that private foundations are usually more expensive to operate, appreciated gifts are deductible only to 20% of AGI, deductions for gifts of real estate to a PF are limited to basis, there is usually a 2% excise tax on investment income and the PF is subject to various rules on self-dealing, minimum distributions and excess business holdings. "Wow!" said Lucy, "there are a lot of negatives about private foundations. So why do some of my friends set up private foundations?"
Lucky Lucy Lindstrom's "No Self-Dealing" Charity:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market. Lucy had invested $1,000,000 in a "penny stock" company. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy was delighted with her gain and decided to give the $5,000,000 in stock to a charitable foundation to help those in need.

Lucy discussed several options with her attorney and her favorite charity. One of the options that Lucy was very interested in was a private foundation (PF). She asked her attorney for reasons to select a private foundation. Her attorney noted that private foundations are more expensive to operate, appreciated gifts are deductible only to 20% of AGI, deductions for gifts of real estate to a PF are limited to basis, there is usually a 2% excise tax on investment income and the PF is subject to various rules on self-dealing, minimum distributions and excess business holdings. However, a private foundation would give Lucy full control.
Lucky Lucy Lindstrom's "Hurricane Grants" Idea:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market. Lucy had invested $1,000,000 in a "penny stock" company. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy was delighted with her gain and decided to give the $5,000,000 in stock to a charitable foundation to help those in need.

Lucy discussed several options with her attorney and her favorite charity. One of the options that Lucy was very interested in was a private foundation (PF). She asked her attorney for reasons to select a private foundation. Her attorney noted that private foundations are more expensive to operate, appreciated gifts are deductible only to 20% of AGI, deductions for gifts of real estate to a PF are limited to basis, there is usually a 2% excise tax on investment income and the PF is subject to various rules on self-dealing, minimum distributions and excess business holdings. However, a private foundation would give Lucy full control. This is important to Lucy since she wants to make grants for disaster relief directly to those in need.

Lucy said, "Wow! There are a lot of negatives about private foundations. So why set up a private foundation? And if I fund a private foundation, can I make grants to people who suffered so greatly in a hurricane?"
Lucky Lucy Lindstrom's "Northern Lite Shot" Charity:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients.

Lucky Lucy Lindstrom's "Northern Long Shot" Charity Diversifies:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio. Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a renewable energy company with the name Northern Long Shot, Inc. This company designs and manufactures energy solutions for companies across the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. After this success, Northern Long Shot decided to "spin off" a smaller company with a portion of their energy systems. Lucy exchanged her $5 million in stock for 60% of the stock in Northern Long Shot II, Inc. After the exchange, Lucy decided to give the Northern Long Shot II stock to a private charitable foundation to help those in need.

Lucy discussed several options with her attorney. She asked her attorney about the ability of her private foundation to receive the Northern Long Shot II, Inc. stock. Her attorney noted that private foundations are subject to various rules on self-dealing, minimum distributions and excess business holdings. They also must not invest in a way that would jeopardize the charitable interest.

Lucy said, "Wow! There are a lot of rules for private foundations. Why would my private foundation have to be careful with the type of investments? After all, I am an RIA who has been very successful with investments."
Lucky Lucy Asks if Private Foundations Can Lobby:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio. Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy invested $1,000,000 in stock in a renewable energy company with the name Northern Long Shot, Inc. This company designs and manufactures energy solutions for companies across the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. After this success, Northern Long Shot decided to "spin off" a smaller company with a portion of their energy systems. Lucy exchanged her $5 million in stock for 60% of the stock in Northern Long Shot II, Inc. After the exchange, Lucy decided to give the Northern Long Shot II stock to a charitable private foundation to help those in need.

Lucy has many friends who are active in the renewable energy business. They would like to establish energy systems in another state and it is possible that their success would also benefit Northern Long Shot II, Inc. Lucy discussed several options with her attorney. She asked her attorney about the ability of her private foundation to help in the lobbying effort to open designated locations for energy systems. After all, she thought, her private foundation would benefit if the lobbying efforts were successful and the foundation could do more to help the needy. Her attorney noted that private foundations are subject to various rules on self-dealing, minimum distributions, excess business holdings and taxable distributions. Lobbying by private foundations is not a permitted distribution. Lucy said, "Wow! There are a lot of rules for private foundations. Why would my private foundation have to avoid spending money on lobbying? After all, it could benefit from designated locations for energy systems in other states."
Lucky Lucy Pays Tax on "Northern Long Shot" Foundation Income:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio. Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a renewable energy company with the name Northern Long Shot, Inc. This company designs and manufactures energy solutions for companies across the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. After this success, Northern Long Shot decided to "spin off" a smaller company. Lucy exchanged her $5 million in stock for 60% of the stock in Northern Long Shot II, Inc. After the exchange, Lucy decided to give the Northern Long Shot II stock to a private charitable foundation to help those in need.

Lucy's attorney had previously advised her that private foundations are subject to various rules on self-dealing, minimum distributions, excess business holdings and taxable distributions. Lucy asked her attorney whether her private foundation would be required to pay any tax. Her attorney responded that private foundations must pay an excise tax on income.

Lucy exclaimed, "What! Pay tax? This is a charitable foundation! Why should a charitable foundation have to pay tax? How much tax will be paid?"
Lucky Lucy's Foundation Goes Public:   Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need of a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a renewable energy company with the name Northern Long Shot, Inc. This company designs and manufactures energy solutions for companies across the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. After this success, Northern Long Shot decided to "spin off" a smaller company. Lucy exchanged her $5 million in stock for 60% of the stock in Northern Long Shot II, Inc. After the exchange, Lucy decided to give the Northern Long Shot II stock to a private charitable foundation to help those in need.

After several years of helping those in need through Northern Long Shot Foundation, Lucy discussed future options with her attorney. She was concerned about all of the rules that applied to private foundations. In addition, her grants are now centered on helping children and most of those grants are being made to her favorite children's charity.

Private Letter Rulings

PLR 200024052 "Well-Oiled" Lead Trust Approved:   Taxpayer plans to create a charitable lead unitrust and a charitable lead annuity trust after both taxpayer and spouse pass away. The trusts will be funded with stock from an investment company that owns working interests in oil and gas.

PLR 201142026 Debt Not Acquisition Indebtedness:   Corporation is engaged in the business of oil and gas production. Corporation will find, acquire and operate working interests in oil and gas properties. Foundation made a capital investment in Corporation by purchasing an 80% net profits agreement.

Related Topics on Oil, Gas and Mineral Interests

1.1.4  Gift Reduction Rules:    Gifts of cash are deductible at face value. Most gifts of appreciated property are deductible at fair market value. Value is usually defined as the price that a willing buyer would pay to a willing seller. Reg. 1.170A-1(c)(1). However, some types of property gifts are not deductible at fair market value. For specific policy reasons, these gifts will be reduced in value for deduction purposes.

1.1.5  Gifts of Partial Interests in Property:    Property gifts are normally transfers of an entire asset. If a person gives the charity all rights and title, the gift is normally considered a long-term capital gain gift deductible up to 30% of adjusted gross income. However, if a person gives only part of the property rights, the gift may not be deductible. Sec. 170(f)(3).

Duncan:    In Estate of Vincent J. Duncan Sr. et al. v. Commissioner; T.C. Memo. 2011-255; No. 7549-10 (30 Oct 2011), the Court upheld the Sec. 2053 deduction for interest on a loan to pay estate tax.

      Quiz-Basic



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