INCOME TAX IMPACT OF SURFACE OWNER PIPELINE RIGHT-OF-WAY AGREEMENTS

Transcription

1 INCOME TAX IMPACT OF SURFACE OWNER PIPELINE RIGHT-OF-WAY AGREEMENTS Jeffrey Yourkovich, CPA Yourkovich & Associates 246 Kruger St Wheelig, WV David R. Croft Spilma Thomas & Battle, PLLC 1233 Mai Street, Suite 4000 Post Office Box 831 Wheelig, WV office dcroft@spilmalaw.com

2 Itroductio Mieral owers have received bous paymets for mieral leases related to the Marcellus ad Utica Shale. Surface ladowers i the Marcellus ad Utica Shale regios are seeig sigificat activity i receivig offers to sig "pipelie right-of-way. Pipelies occupy a critical role i the developmet of shale resources. As shale developmet cotiues to expad, so does the eed for pipelies that trasport shale gas resources.. 2

3 Paymets For Pipelie Right-Of-Way The paymet for this right-of-way amouts to a easemet. The icome tax treatmet of easemets may trigger Ø ordiary icome, Ø capital gai icome, Ø a reductio i basis of all Ø or part of the lad, or combiatio of the three. 3

4 Pipelies 4

5 Time To Report The Paymet To The IRS What to do? 5

6 Real Property Iterests Uderstad what iterest is beig coveyed, if ay. Property is a budle of rights or a budle of sticks. Property law comes from three sources: the commo law, statutes, ad the Costitutio. 6

7 Geeral Priciples of Oil ad Gas Iterests Ecoomic Iterest Operatig v. No-Operatig Iterest Lease Coveyaces Sale or Lease Geeral Cosideratios Lease Rights Royalties Productio Paymets Retaied Productio Paymet 7

8 Easemets Geerally A easemet is a iterest i real estate that gives the holder the right to use, but ot to possess, the real estate. Express easemet Easemet appurteat Ø domiat teemet Ø serviet teemet Ø affirmative easemet Ø egative easemet Easemet i gross Implied easemet Easemet by ecessity Easemet by prescriptio Coservatio Easemet 8

9 Types of Easemets Rights of way Driveway easemets Utility easemets Light ad air easemets Fece easemets Water easemets Sport or recreatioal easemets Flowage easemets Pipelie Easemet - gives the easemet holder the right to build ad maitai a pipelie o a ladower s property. It does ot grat the easemet holder actual owership of the lad, just a right to use the lad for pipelie purposes. The term right-of-way agreemet = easemet 9

10 Icome Taxatio Of Paymets Icome. 61, except as otherwise provided i the Code, a taxpayer must iclude i gross icome all icome from whatever source derived. Character of Icome Ordiary Capital Gai Burde of Proof. As with most civil tax matters, the burde is o the taxpayer to prove the uderlyig ature of a particular paymet. Damages to Property. I lieu of what were the damages awarded? Paymet for damage to property = recovery of capital Paymet for use of property = ordiary icome Paymet for lost profits = ordiary icome Costructive Receipt ad Ecoomic Beefit Doctrie. 10

11 Icome Tax Treatmet of Pipelie Paymets. Recogitio of Gai or Loss. Code 61(a)(3) provides that gross icome icludes gais derived from dealigs i property. A sale of a perpetual easemet costitutes a sale of a iterest i lad. Paymet for temporary easemet = ret Paymet for permaet easemet = recovery of basis Nature of Property. The ature of the asset coveyed must be determied. Lad may be a capital asset held for ivestmet or persoal use, Code 1231 property (which is property used i a trade or busiess, icludig property subject to ivolutary coversio), or stock i trade. Impairmet (Damage) To Property. The retur of capital doctrie provides a exceptio to the defiitio of gross icome uder

12 Icome Tax Treatmet of Pipelie Paymets. Timber. The capital gai/loss geeral rules of Code 1221 or 1231 usually apply to a sale or exchage of stadig timber ad timberlads if the property is ot ivetory or other property held for sale to customers i the ordiary course of busiess. Allocatio. The property ower must allocate basis to the easemet tract to determie the amout of gai or loss realized. Reg (a) provides more specifically that [w]he a part of a larger property is sold, the cost or other basis of the etire property shall be equitably apportioed amog the several parts, ad the gai realized or loss sustaied o the part of the etire property sold is the differece betwee the sellig price ad the cost or other basis allocated to such part. 12

13 Icome Tax Treatmet of Pipelie Paymets. Iaja Lad Co., Ltd. Tax Court Case Leases ad Liceses. Trasactios characterized as leases or liceses give rise to retal icome, with o offset of basis. Reversioary Rights. Retaiig certai reversioary rights ca frustrate sale treatmet. A reversio right causes the easemet to revert to the origial ower upo the occurrece or ooccurrece of a evet, coditio, or fact. A reversioary evet that ecessarily or probably will occur, such as the passage of a term of years, is fatal to easemet status. Easemets for pipelies, surface sites, ad roads that are for a defiite term of years are cosidered leases. 13

14 Icome Tax Treatmet of Pipelie Paymets. Periodic Paymets. Provisios callig for periodic paymets bear idicia of a lease. Paymets for Temporary Workspace. Desigatig such space as a temporary easemet ad allocatig paymets to its use will trigger retal icome Damage Paymets. Rev. Rul , the Commissioer cosidered the tax cosequeces of a lump sum paymet for damages caused by the costructio of a pipelie. Commissioer adopted the traditioal recovery of basis aalysis used i Raytheo ad Iaja Lad, but foud that, although the agreemet specified that damages to feces, improvemets, ad crops were icluded i the advace paymet, the oly damage icurred at the time of the paymet was a aticipated loss of retal icome due to crop curtailmet. Therefore, taxpayer was ot etitled to treat the paymet as retur of capital. 14

15 Icome Tax Treatmet of Pipelie Paymets. Severace Damage Allocatio. Severace damages are paymets i additio to a codematio award which are paid to the ower where oly part of the property was codemed ad the value of the part of the property retaied was decreased as a result. Gilbertz Case. I Gilbertz, the Teth Circuit costrued paymets for future damages as retals, where a statute limited the ladower s right to recover to istaces of ureasoable or egliget use, ad there was o evidece of actual damages caused by such coduct. Emiet Domai. Emiet domai (sometimes referred to as codematio), is the power of the govermet to take private property for the public use without the coset of the ower. I 15

16 Icome Tax Treatmet of Pipelie Paymets. Relocatio Paymets. Some emiet domai statutes require paymets for the expese of relocatig fixtures ad persoalty. Codemed Property. The IRS positio is that a codematio award must segregate severace damages ad other compoets, or else a presumptio exists that the award was oly for the property take. Ivolutary Coversio. A ivolutary coversio is the complete or partial destructio, theft, seizure, requisitio or codematio or sale or exchage uder threat of immiet requisitio or codematio of a taxpayer s property. 16

17 Icome Tax Treatmet of Pipelie Paymets. Deferral Uder Code Uder Code 1001(c) gai or loss realized from the sale or other dispositio of property must geerally be recogized. A importat exceptio to this geeral rule is provided by Code 1033, which allows gai realized from certai ivolutary coversios of property to be recogized or deferred at the taxpayer's electio. Codematio of Property With Residece. Trasactio Reportig. The party acquirig the easemet is resposible for reportig the real estate trasactio o Form 1099-S. Where damages or rets are paid, they are reported o Form MISC. The IRS has stated that, for dispositios of timber, paymets of timber royalties uder a pay-as-cut cotract are to be reported o Form 1099-S, Proceeds From Real Estate Trasactios. 17

18 Icome Tax Treatmet of Pipelie Paymets. Deferral Uder Code Uder Code 1001(c) gai or loss realized from the sale or other dispositio of property must geerally be recogized. A importat exceptio to this geeral rule is provided by Code 1033, which allows gai realized from certai ivolutary coversios of property to be recogized or deferred at the taxpayer's electio. Codematio of Property With Residece. Trasactio Reportig. The party acquirig the easemet is resposible for reportig the real estate trasactio o Form 1099-S. Where damages or rets are paid, they are reported o Form MISC. The IRS has stated that, for dispositios of timber, paymets of timber royalties uder a pay-as-cut cotract are to be reported o Form 1099-S, Proceeds From Real Estate Trasactios. 18

19 Case Study Lad Ower A received the followig checks from Eergy Compay C durig the caledar tax year: $160, , , , , , $196,

20 Case Study Lad Ower A received two Form-1099s for the tax year: Form 1099-Misc Box 3 Other Icome 97, Form 1099-S Proceeds from Real Estate Trasactios 98, Total $196, Other facts to cosider are the Lad Ower basis i the real estate: Purchased 2/3 lad & mierals 78,300 Iherited 1/3 lad 100,000 Iherited 1/3 mierals 100,967 Cost of Lad & Mieral Appraisals 3,350 Lad Ower is a Farmer with acres 20

21 Case Study Lad Ower ad the tax preparer had to figure out the followig whe preparig the tax retur: Ø How do you recocile the checks with the 1099s received? Ø Where do you report the above checks ad correspodig 1099s? Ø Basis eeds calculated. Ø How do you allocate basis betwee the differet trasactios? Ø O what Form or Schedule do you report the trasactios? 21

22 Case Study The case study tax retur as filed Reported o Form Ø Schedule F icome from crop damage Misc Box 3 Ø Damages with basis allocated o Form , Misc Box 3 Ø ROW with basis allocated o Form , S Ø Damages with basis allocated o Form , Misc Box 3 Ø Roadway Optio with basis allocated o Form , S Ø Surface Site Damages with basis allocated o Form , S Ø ROW with basis allocated o Form , S Total 196,

23 Case Study Tax Retur Aalysis Ø Ø Ø Ø Ø Sice the taxpayer is a Farmer ad had defiable crop damages, a portio of the proceeds ($840) were reported o Schedule F. Sice the taxpayer is a Farmer, all of the moey received for ROWs ad damages were reported o Form Properly allocatig basis ca reduce taxable icome. Properly idetifyig the ature of the icome allowed for recogitio of lower capital gai tax treatmet versus ordiary icome. Proper treatmet of icome, use of basis ad the applicability of capital gai treatmet versus ordiary icome saved the taxpayer $47,000 (other facts, icome ad deductios about the case study tax retur have bee left out for simplicity reasos). 23

24 Case Study This case study demostrates the eed to reach beyod the actual 1099 reportig forms received (ad eve i some cases ot received) to uderstad the ature ad character of the paymets. Use the agreemets ad documetatio available to support the proper filig of the retur with the uderstadig that the IRS may evetually sed correspodece where we eed to respod ad support the filed retur. 24

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26 The Ed Thak you 26