SEPARATING MINERAL INTERESTS FROM THE SURFACE MAY RESULT IN TWO REAL PROPERTY TAX BILLS

by Larry Gearhardt, OSU Income School Director

Some landowners in the oil and gas drilling area of Ohio may receive two real property tax bills for the same property. How can this happen? When the mineral interests are separated from the surface, the Ohio Revised Code (section 5713.04) requires the county auditor to list and value the land in separate entries, specifying the interest listed, and tax the parties owning the different interests. If the same person owns both the surface and the separated mineral interests, he may receive two property tax bills. This has surprised some landowners after the separation of the mineral interests.

WHY WOULD A LANDOWNER SEPARATE MINERAL INTERESTS BUT RETAIN OWNERSHIP?
Some landowners are taking the proactive step of separating the mineral interests from the surface for succession planning and tax management. It is not uncommon for a trust to be used. When we say that the landowner retains ownership of both the surface and mineral interests, we are also including the scenario where the mineral interests are separated and placed in a trust for the benefit of the surface owner. Each landowner has his own reason for doing this, but one reason is that it may provide flexibility when doing succession planning.

ONE LANDOWNER RECEIVING TWO PROPERTY TAX BILLS HAPPENS IN ONLY RARE CIRCUMSTANCES
The focus of this paper is on the very narrow circumstance where a landowner separates the mineral interests from the surface, by deed, and retains ownership of both interests, either personally or in trust, and the mineral interests are not yet developed.

Leasing mineral rights to another entity does not cause a separate tax bill. A lease is merely an equitable interest in property that allows another to explore for minerals and develop those minerals if found. The landowner normally receives a lease signing bonus and shares in the royalties from the well. OSU Extension Factsheets explain the income tax and Ohio CAT tax treatment of those proceeds.

If the mineral rights are separated from the surface by deed and sold to another person, there may be a new tax bill created, but the new tax bill is sent to the owner of the mineral interests. The landowner pays only the property taxes on the surface.

If the mineral interests are developed, the mineral interests are valued according to a formula that is based on production and is provided by the Ohio Department of Taxation

WHAT IS THE VALUE OF AN UNDEVELOPED MINERAL INTEREST?
Determining the value of a producing well for property tax purposes is clearer than determining the value of an undeveloped mineral interest. The Ohio Administrative Code (sec. 5703-2-11(I)) provides that oil and gas rights that have been separated shall be valued in accordance with an annual entry of the Ohio tax commissioner. This annual entry is based upon a uniform formula and is required to be used in all eighty-eight counties. The property value depends upon the production of the well. A sharp negotiator would make the developer responsible for this tax.

So how does the auditor value mineral interests that have been separated, but not yet developed into a producing well? Once again, we look to Ohio Administrative Code sec. 5703-25-11 (I). A literal reading of this Ohio Administrative Code section makes no distinction between oil and gas rights that have been developed and those that have not been developed. Instead, the auditor is directed to value oil and gas rights that have been separated according to the annual entry of the tax commissioner. The entry is based on production. Since there is no production, one can reasonably conclude that the value of separated, but yet undeveloped, mineral rights would be zero.

Notwithstanding the Ohio Administrative Code section, some county auditors have assigned values of $200, $300, or $400 per acre. The value assigned by the county auditor is based on the level of activity and amount of production in the area, as well as historical practices. County auditors are looking for some guidance in the future to clarify how to determine the value of a separated, but yet undeveloped mineral interest.

CONCLUSION

Tax management and succession planning are very important. Landowners should seek advice from a trained professional to prepare a plan that fits their needs. Part of the plan is to be aware that a separation of mineral rights, by deed, with retained ownership in the name of the surface owner may cause the landowner to receive two real property tax bills. The best recommendation at the present time is to check with your county auditor to see what the value of that undeveloped mineral interest will be.

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