IRS lets a royalty company treat its adjacent nonoperating mineral interests as a single property for depletion

Plain-English summary

A company that owns oil, gas, and mineral royalty interests (but does not itself drill, develop, or operate the properties) asked the IRS for permission to combine many separate "nonoperating" mineral interests in one area and treat them as a single property for tax purposes. Why it matters: owners of mineral interests get a "depletion" deduction as the resource is extracted, and the tax law normally treats each separate interest in each tract as its own property, which can make computing cost depletion very burdensome, especially when reserve data is not available property by property. Internal Revenue Code § 614(e) lets a taxpayer aggregate two or more separate nonoperating mineral interests in a single tract or in adjacent tracts, but only if the taxpayer shows that a principal purpose of the aggregation is not tax avoidance. The company represented that its interests are royalty-type interests that bear no production costs, that the tracts are contiguous or in close proximity, and that aggregation would simply reduce administrative burden and match its book accounting, without producing extra depletion deductions. The IRS concluded the requirements of § 614(e) were met and granted permission to aggregate the interests in that area into one property, conditioned on each royalty interest qualifying as an economic interest and on the taxpayer keeping the supporting maps and descriptions in its records.

Ruling snapshot

• Question: May a royalty owner aggregate its separate nonoperating mineral interests in adjacent tracts and treat them as one property under § 614(e)?
• Outcome: approved (permission granted to aggregate the nonoperating mineral interests in the area as one property, conditioned on each interest being an economic interest under § 611)
• Key authorities: IRC §§ 614(a), 614(e), 611, 613; Treas. Reg. §§ 1.614-1, 1.614-2, 1.614-5

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202150005 Third Party Communication: None
Release Date: 12/17/2021 Date of Communication: Not Applicable
Index Number: 614.04-00
Person To Contact:
----------------- ------------------, ID No. ---------------
------------------------------ Telephone Number:
------------------------------------------ --------------------
---------------------------------------------- Refer Reply To:
------------------------------------------- CC:PSI:B06
PLR-107021-21
Date:
August 18, 2021
In Re: Request to aggregate nonoperating
mineral interests

LEGEND

Taxpayer = ----------------------------------------------------------------------
Parent = ---------------------------------------------------------------
HoldCo = ------------------------------------------------------------------------------------------
Subsidiary 1 = ------------------------------------------------------------
Subsidiary 2 = -----------------------------------------------------------------------
Date 1 = ---------------------
Date 2 = --------------------------
State = -------------
Location 1 = -----------------------
Location 2 = ----------
Area = ------------------------------------------------
a = --------------------------
b = --------------
Auditor = ----------------------------------

Dear ------------:

This letter replies to a letter dated Date 1 in which Taxpayer requests permission to
form aggregations of separate nonoperating mineral interests under § 614(e) of the
Internal Revenue Code (Code) and § 1.614-5(d) of the Income Tax Regulations
(Regulations). The request is submitted in respect of nonoperating mineral interests
held in Location 1.

   The facts and representations submitted are summarized as follows:

     Taxpayer is a U.S. corporation incorporated pursuant to the laws of State.

Taxpayer is a calendar year taxpayer and utilizes the accrual method of accounting.
Taxpayer is a wholly-owned subsidiary of Holdco, which is also incorporated pursuant to
the laws of State, a calendar year taxpayer, and utilizes the accrual method of
accounting. Taxpayer owns 100% of the membership interests of Subsidiary 1, which is
treated as a disregarded entity for U.S. Federal tax purposes. Taxpayer wholly owns
Subsidiary 2, a corporation incorporated pursuant to the laws of State. Together,
Holdco, Taxpayer, Subsidiary 1, and Subsidiary 2 are an affiliated group of corporations
that file a consolidated U.S. federal income tax return with Holdco serving as the
common parent. Holdco is owned by Parent, a company organized in Location 2.

   Parent, along with Holdco, Taxpayer, Subsidiary 1, and Subsidiary 2, is an

international mineral resource and investment company that acquires mineral, oil, and
natural gas royalties and other nonoperating mineral interests worldwide. Parent,
Holdco, Taxpayer, Subsidiary 1, and Subsidiary 2 do not explore, develop, or operate
any of the properties in which they hold interests, but instead rely on non-operating
income streams, such as royalties on mineral interests, as the basis of their income.
Parent prepares its financial statements based on the International Financial Reporting
Standards as issued by the International Accounting Standards Board.

   The mineral interests that are the subject of the request are located in Area.

For U.S. federal income tax purposes, all of the interests are treated as owned

directly by Taxpayer. Taxpayer acquired the mineral royalty interests in respect of each
of these properties on Date 2. Taxpayer represents that the interests consist of mineral
royalty interests, nonoperating oil and gas production overriding royalty interests, non-
participating royalty interests, and royalty interests. Each production royalty interest
acquired by Taxpayer will be referred to as a "royalty interest." Included in the
acquisition, Taxpayer paid a in consideration for b properties.

Taxpayer represents that it does not have the ability or desire to operate any of the

properties to produce oil and gas therefrom. Taxpayer further represents that the
royalty interests afford Taxpayer the right to royalties, including royalties from acquired
leases. Taxpayer does not bear the cost of exploration, development, nor production in
respect of any of the properties. Taxpayer represents that each of the properties
subject to a lease are operated by other unrelated persons, and that the leases are for
tracts of land that are either contiguous, touching at one point (checker-board pattern of
ownership), or reasonably close in proximity to each other. Taxpayer represents that,
because Taxpayer does not incur any costs of production, all of the royalty interests are
nonoperating mineral interests.

Taxpayer represents that aggregation of the nonoperating mineral interests would
enable Taxpayer to compute, without undue burden, its cost depletion deduction in
accordance with §§ 611 and 612 of the Code and § 1.611-2 of the Regulations.
Aggregation of the nonoperating mineral interests at the properties are necessary to
compute cost depletion because reserve information is not available to Taxpayer on a
separate property-by-property basis. To determine the appropriate reserves for each
property, Taxpayer would generally be required to reply on publicly available
information, and where possible, engage third-party experts. Taxpayer and Parent
represent that they will rely on the same reserve information to compute book cost
depletion in the aggregate for the property in the preparation of consolidated financial
statement audited by Auditor and for regulatory filings. Taxpayer represents that
granting permission to aggregate nonoperating mineral interests into a single property
will reduce administrative burden in calculating depletion and allows Taxpayer to
implement consistent treatment for financial accounting and U.S. federal income tax
purposes.

Taxpayer represents that a principal purpose of its submitting this Request for the

aggregation of nonoperating mineral interests held at Area is not the avoidance of tax.
Taxpayer makes this representation supported by two bases. First, Taxpayer does not
bear the costs of exploration, development, or production of oil and gas produced with
respect to these nonoperating mineral interests. Therefore, it is highly likely that the
percentage depletion deduction for each interest would be subject to the taxable income
limitation contained in § 1.613-5 of the Regulations, as only general and administrative
costs plus any severance and ad valorem taxes will be allocated to each interest for the
purpose of computing the taxable income limitation. Aggregating the nonoperating
mineral interests in Area into a single property is not expected to alter this result, as no
additional percentage depletion deductions would be expected to be allowed if
permission to aggregate is granted. Second, aggregating the nonoperating mineral
interests in the defined areas into a single property will not alter the total amount of cost
depletion deductions allowed over the life of the properties, as the total cost depletion
deductions allowed for the properties cannot exceed the depletable tax basis allocated
to the interests in the properties. Accordingly, no cost depletion deductions in excess of
those to which Taxpayer would otherwise be entitled would be expected if such
nonoperating mineral interests are aggregated into a single property.

Taxpayer represents that an abandonment loss on any aggregated nonoperating

mineral interests will not be taken until all of the mineral rights in the entire aggregated
or combined property are proven to be worthless, or until the entire aggregated or
combined property is disposed of or abandoned pursuant to § 1.614-6(d) of the
Regulations.

                                   Ruling Requested

The ruling request seeks the aggregation of the nonoperating mineral interests held

at the Area, such that the separate nonoperating mineral interests is treated as one
property for U.S. federal income tax purposes, pursuant to Internal Revenue Code
section 614(e) and Treasury Regulation section 1.614-5(d).

Taxpayer represents the principal purpose of submitting this Request for the
aggregation of nonoperating mineral interests in Area into a single property is not for the
avoidance of U.S. Federal income tax.

                                  Law and Analysis

   In the case of mines, wells, and other natural deposits, § 614(a) of the Code and

§ 1.614-1(a)(1) of the Regulations define the term "property" to mean each separate
interest owned by the taxpayer in each mineral deposit in each separate tract of parcel
of land.

   Under § 614(e) and § 1.614-5(d), a taxpayer that owns two or more separate

nonoperating mineral interests in a single tract or parcel of land or in two or more
adjacent tracts or parcels of land, may request permission to aggregate all the interests
and treat them as one property.

     Section 1.614-5(e) provides that an application for permission to aggregate

separate nonoperating interests under § 614(e) and § 1.614-5(d) must be made in
writing to the Commissioner and must be filed within 90 days after the beginning of the
first taxable year beginning after December 31, 1957, for which aggregation is desired
or within 90 days after the acquisition of one of the nonoperating mineral interests that is
to be included in the aggregation, whichever is later.

   Section 1.614-1(a)(2) of the Regulations defines the term "interest" as an

economic interest in a mineral deposit. It includes working interests or operating
interests, royalties, overriding royalties, net profits interests, and, to the extent not
treated as loans under § 636 of the Code, production payments.

   Section 614(e) of the Code provides that if a taxpayer owns two or more

separate nonoperating mineral interests in a single tract or parcel of land or in two or
more adjacent tracts or parcels of land, the Secretary shall, on a showing by the
taxpayer that a principal purpose of forming the aggregation is not the avoidance of tax,
permit the taxpayer to treat all such interests as one property for all subsequent taxable
years unless the Secretary consents to a different treatment.

   Section 614(e)(2) of the Code and § 1.614-5(g) of the Regulations define the

term "nonoperating mineral interests" to include only interests described in § 614(a) that
are not operating mineral interests within the meaning of § 1.614-2 of the Regulations.

   Section 1.614-2(b) of the Regulations defines the term "operating mineral

interest" to mean a separate mineral interest as described in § 614 of the Code, in
respect of with the costs of production are required to be taken into account by the
taxpayer for purposes of computing the limitation of 50 percent of taxable income from
the property in determining the deduction for percentage depletion under § 613, or such
costs would be so required to be taken into account if the mine, well, or other natural
deposit were in the production stage. The term does not include royalty interests or
similar interests, such as production payments or net profits interests.

    Section 1.614-5(d) of the Regulations provides that upon proper showing to the

Commissioner, a taxpayer who owns two or more separate nonoperating mineral
interest in a single tract or parcel of land, or in two or more adjacent tracts or parcels of
land, shall be permitted, under § 614(e) of the Code, to form an aggregation of all such
interests in each separate kind of mineral deposit and treat such aggregation as one
property. Permission shall be granted by the Commissioner only if the taxpayer
establishes that a principal purpose in forming the aggregation is not the avoidance of
tax. The fact that the aggregation of nonoperating mineral interests will result in a
substantial reduction in tax is evidence that the avoidance of tax is a principal purpose
of the taxpayer. An aggregation formed under § 1.614-5(d) shall be considered as one
property for all purposes of the Internal Revenue Code. In no event may nonoperating
interests in tracts or parcels of land that are not adjacent be aggregated and treated as
one property. The term "two or more adjacent tracts or parcels of land" means tracts or
parcels of land that are in reasonably close proximity to each other depending on the
facts and circumstances of each case. Adjacent tracts or parcels of land do not
necessarily have any common boundaries, and may be separated by intervening
mineral rights.

   Section 1.614-5(e)(1) of the Regulations provides that an application for

permission to aggregate separate nonoperating interests under § 614(e) of the Code
and § 1.614-5(d) must be made in writing to the Commissioner and must be filed within
90 days after the beginning of the first taxable year beginning after December 31, 1957,
for which aggregation is desired or within 90 days after the acquisition of one of the
nonoperating mineral interests that is to be included in the aggregation, whichever is
later.

    Section 1.614-5(e)(4) of the Regulations provides that the application for

permission to aggregate nonoperating mineral interests under § 614(e) of the Code and
§ 1.614-5(d) shall include a complete statement of the facts upon which the taxpayer
relies to show that the avoidance of tax is not a principal purpose of forming the
aggregation. Such application shall also include a description of the nonoperating
mineral interests within the tract or tracts of land involved. A general description,
accompanied by maps appropriately marked, which accurately circumscribes the scope
of the mineral interests in a particular kind of mineral deposit within the tract or tracts of
land involved will be sufficient. If the Commissioner grants permission, a copy of the
letter granting permission shall be attached to the taxpayer's return for the first taxable
year for which such permission applies. If the taxpayer has already filed such return, a
copy of the letter of permission shall be filed with the district director for the district in
which such return was filed and shall be accompanied by an amended return or returns
if necessary or, if appropriate, a claim for credit or refund.

     Section 1.614-5(e)(5) of the Regulations provides that the election to aggregate

separate nonoperating mineral interests under § 614(e) of the Code and § 1.614-5(d) is
binding upon the taxpayer for the first taxable year for which the request is made and
for all subsequent taxable years unless consent to make a change is obtained from the
Commissioner.

  Therefore, to obtain permission, the taxpayer must:
  1) Apply for permission within 90 days after the beginning of the first taxable
     year for which aggregation is desired, or within 90 days after the acquisition of
     one of the properties to be included in the aggregation (§ 1.614-5(e)(1));
  2) Provide maps, descriptions of the nonoperating interests, and a complete
     statement of facts (§ 1.614-5(e)(4)); and
  3) Establish that a principal purpose for forming the aggregation is not tax
     avoidance. A substantial reduction in taxes is evidence that the avoidance of
     taxes is a principal purpose (§ 1.614-5(d) and § 1.614-5(e)).

    Taxpayer represents that the interests owned at each of the properties are

"nonoperating mineral interests" as that term is defined in § 1.614-5(g) of the
Regulations, and that the royalty interests are interests that do not bear the costs of
exploration, development, or production. Taxpayer also represents that the interests at
each property at issue are in tracts or parcels of land that are "adjacent" or "in
reasonably close proximity to each other" as provided in § 1.614-5(d) of the
Regulations. Additionally, Taxpayer represents that the maps for the property included
in the ruling request demonstrate that the nonoperating interests are in reasonably close
proximity to each other, as these interests are either contiguous, touch at a corner, or
are separated by intervening mineral rights but included in a single operating mine.

   Finally, Taxpayer represents that the principal purpose of forming the requested

aggregation is not tax avoidance. The purpose of forming the requested aggregation is
to reduce administrative burden in calculating depletion and allow Taxpayer to
implement consistent treatment for financial accounting and federal income tax
purposes.

                                         Ruling

  Taxpayer requests permission under § 614(e) and § 1.614-5(d) to aggregate the

separate nonoperating mineral interests owned by Taxpayer in the Area, such that the
separate nonoperating mineral interests are treated as one property.

   Taxpayer has represented that it acquired multiple royalty interests in the Area.

Taxpayer also has submitted descriptions and maps indicating that each of the royalty
interests is adjacent to the other royalty interests within the meaning of § 1.614-5(d).
Moreover, Taxpayer has represented that the avoidance of tax is not a principal
purpose of forming the aggregation within the Area.

   Based on the representations made and consideration of the descriptions and

maps submitted, we conclude that the requirements of § 614(e) and § 1.614-5 of the
Regulations have been met. Based solely on the facts and representations submitted,
we grant consent for Taxpayer to aggregate the separate nonoperating mineral interests
located in the Area, such that those properties are aggregated and treated as one
property for U.S. federal income tax purposes.

   Except as specifically set forth above, we neither express nor imply any opinion

concerning the federal income tax consequences of any aspect of any transaction or
item discussed or referenced in this letter. This ruling is conditioned on each royalty
interest qualifying as an economic interest under § 611 of the Code before the
aggregation. General descriptions of the nonoperating interests accompanied by maps
are to be on file with the books and other records that are necessary for examination by
the Service.

  The rulings contained in this letter are based upon information and

representations submitted by Taxpayer and accompanied by a penalties of perjury
statement executed by an appropriate party. While this office has not verified any of the
material submitted in support of the request for rulings, it is subject to verification on
examination.

   In accordance with the power of attorney, we are sending copies of this letter to

Taxpayer's authorized representatives. We are also sending a copy of this letter to the
appropriate Industry Director, LB&I. A copy of this ruling must be attached to any
federal income tax return to which it is relevant. Alternatively, taxpayers filing their
returns electronically may satisfy this requirement by attaching a statement to their
return that provides the date and control number of the letter ruling.

                                  Sincerely,

                                  Patrick Kirwan

                                  Patrick Kirwan
                                  Branch Chief, Branch 6
                                  Office of Associate Chief Counsel
                                  (Passthroughs & Special Industries)

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