A gift of mineral rights can make a wonderful gift to charity. Here is what donors and charities need to understand about gifts of mineral rights.

What are Mineral Rights?

The owner of real property (land) has many rights associated with their ownership. These rights include the right to possess; to occupy; to exclude others; and the ability to transfer, use or rent the land. Property rights also include water rights or the right to use water from surface or ground sources and air rights or the right to use the space above the land.

Property rights also often include mineral rights, which is the right of the landowner to "exploit, mine or produce any of the minerals that lie below the surface of the property." These minerals may include oil, gas, coal and precious metals but exclude sand, gravel, limestone and subsurface water rights as these are considered part of the ownership rights of the surface owner.

There are three general rights associated with a person's mineral ownership. The owner of mineral rights has the right to:

1. Use as much of the surface area of the real property that is reasonably necessary to exercise the owner's rights over the minerals, basically to access the minerals;
2. Sell, lease and convey ownership of the mineral rights; and
3. Receive payment from third parties with whom the owner enters into a mineral lease or oil and gas lease (such as bonus payments, delayed rents and royalties).

Transferring Mineral Rights

Typically, when the owner of real estate transfers their property to another party the mineral rights convey with the land. This is not always the case, however, as mineral rights can be severed from the surface rights and conveyed separate and apart from the land. Accordingly, one party can own the land itself while another party owns the mineral rights. In such a case, the owner of the mineral rights has the right to enter unto the surface area of the land and use that portion of the surface area of the land that is reasonably necessary for the mineral rights owner to exercise their rights.

The transfer of mineral interests is accomplished when the owner of those rights (the "grantor"): (1) transfers their mineral rights by signing a deed of conveyance and (2) delivers that deed to the other party (the "grantee"). It is important for the grantee to record this deed with the appropriate government office to give "record notice" of their ownership of the mineral rights and to preclude anyone else from making a competing claim against their rights. A deed of conveyance for mineral rights is recorded in the same way that a deed conveying real property ownership of real estate is recorded. In the United States, these deeds are typically recorded in the county recorder or county registrar's office in the county and state in which the land is located.

The conveyance of mineral rights can also occur by way of a testamentary transfer by a provision included in the owner's will. In cases of testamentary transfers, the executor of the estate would deliver a deed of conveyance to the beneficiary and the deed would be recorded as described above.

Tax Treatment of Gifts of Mineral Rights

Overview of Partial Interest Rule

Under the partial interest rule, a donor cannot generally take a charitable deduction if the donor donates an undivided interest in property to charity. For example, if a donor owns the land and certain water rights, the donor cannot take a deduction for a donation of the land and still retain the water rights. Reg. 1.170A-7(a).

A donor may make an undivided gift to charity of each and every interest he or she owns in the property and that gift will qualify for a deduction. Reg. 1.170A-7(b). For example, a donor could donate an undivided 10/12ths interest (or 10 months of exclusive use) of a home and all of the property rights associated with the land it sits on to charity and retain the use of the property for two months (July and August) for himself. The gift of 10/12ths would be deductible. See PLR 9303007.

For more on the partial interest rule, please see GiftLaw Pro Chapter 1.1.5.

Gift When Owner Owns Land and Mineral Rights

When the donor owns the land and the oil and gas rights under the surface, the donor cannot make a contribution of less than the donor's entire interest and receive a charitable deduction. Sec. 170(f)(3)(A). However, one of the exceptions to the partial interest rule permits the donor to take a deduction when making a gift of an undivided portion of the donor's entire interest in the property. Sec. 170(f)(3)(B). In such a case, the donor must give the gift of land together with the mineral rights (oil and gas) in order to receive a charitable deduction.

The gift of land with oil and gas rights may be made outright to charity or as part of a gift to fund a life income arrangement, such as a charitable remainder trust (CRT) or charitable gift annuity (CGA). Please see the "CRT and CGA Transfers" section below for more information on life income gifts funded with mineral rights.

Gift When Owner Owns Only Mineral Rights

If a donor only owns mineral rights, the donor can gift the mineral rights alone to charity or to a charitable trust. It is not necessary for the owner to acquire ownership interests he does not have, such as the surface rights to the property. The gift of the mineral rights alone is sufficient to claim a charitable deduction. In other words, in cases where a donor owns mineral rights but not the land the partial interest rule is not implicated. Sec. 170(f).

Gift of Mineral Rights Royalties

In cases where the donor has leased her mineral interests, she may gift the royalty stream to charity. The donor may also use this gift to fund a CRT. In such a case, there is no issue of income avoidance because a royalty is not earned income. See Lucas v. Earl, 281 U.S. 111 (1930). Since the royalty payment is assigned, the donor avoids income tax on the payment. While there are no specific cases on point, under the "fruit of the tree" analysis a gift of an ordinary income stream of dividend payments does not produce a charitable deduction. Sec. 170(e)(1).

Special Rules Related to Certain Gifts

As with other gifts, the donor of a gift of a mineral interest must have held the interest for more than one year in order to take a deduction equal to the fair market value of that gift. Sec. 170(e).

Additionally, if the fair market value of a gift, including a gift of mineral rights, is worth $500 or more, the donor must include a completed Form 8283 as part of their annual tax return in order to claim a charitable deduction. In cases where the gift of mineral rights is worth more than $5,000 in value, the donor is required to obtain a qualified appraisal of that gift or the charitable deduction may be denied. Reg. 1.170A-13(c). See GiftLaw Pro Chapter 1.5.2.

CRT or CGA Transfer Issues

In cases where a leased interest is transferred to fund a life income plan, such as a CRT or a CGA, it is important to assess whether the royalty payment is sufficient to sustain the desired payout (assuming the charity retains the interest). Due to the potentially uncertain nature of the payout stream associated with mineral interest (for example, an oil well may run dry), a NIMCRUT or FLIP payout may work best. It may be difficult for a charity to maintain a fixed payment arrangement, such as a CGA, for the very reason that minerals are depleting assets. Over time the royalties received from a mineral rights lease may be insufficient to meet the CGA's payment obligations.

Mineral Rights and UBIT

Because royalties are regarded as passive income, the income from a mineral rights lease is generally not subject to unrelated business income taxes (UBIT). Sec. 512(b)(2). In a series of rulings, the Internal Revenue Service has held that the income is not subject to UBIT so long as the royalty interest in not a "working interest" controlled by the charity. In other words, the charity cannot be responsible or liable for the operational expenses associated with developing the minerals. Rev. Rule. 69-179; PLR 7741004. The IRS has also said that it will not permit charities to characterize income from a working interest as royalties to avoid UBIT. Rev. Rul. 69-192.

A Word of Caution

As with any gift of real property, there is the potential for environmental contamination on the property. Be sure to conduct proper environmental assessments of the property before accepting a gift. For more on this subject, see Chapter 5.2 of GiftLaw Pro.

Examples of Gifts of Mineral Rights

1. Gift of Land, Donor Retains Mineral Rights

Norman McLean is a farmer in Big Sky Country. He and his wife Jessie have, over the years, acquired substantial land holdings in Montana. They have decided to make a substantial gift of real estate to The River Runs Through It Academy, a qualified charity that is a fly-fishing camp for underprivileged, inner-city kids. Paul wishes to make the gift to the Academy to endow several scholarships bearing the name of Norman's late brother, Paul, who was an avid fly-fisherman.

Norman and Jessie have decided to gift the land but they want to retain the mineral rights, having recently learned that the land may have valuable oil and gas deposits. Because Norman and Jessie own both the surface and mineral rights of the land, they would be unable to claim a charitable deduction if they give only the surface rights to the Academy.

2. Gift of Land and Mineral Rights

Bob Beauffalo and his sons own and operate a 2,000 acre buffalo ranch in Colorado. They are very charitably minded and have long supported the Colorado Youth Foundation, a qualified charity that helps teach civic values to boys and girls ages 8 to 18. Bob and the boys have decided to give 20 acres to the Foundation for purposes of operating an overnight camp for kids.

Despite the fact their buffalo ranch has valuable gold deposits underneath the land, Bob and his sons have decided to give the land and the mineral rights associated with the land to the Foundation. Bob and his sons would be able to take a charitable deduction for their gift because they have given their entire interest in the 20 acres to charity. Because the gift is worth more than $5,000 they will have to obtain a qualified appraisal and complete Form 8283 as part of their individual tax returns.

3. Gift of Undivided Interest

Several years ago, Bob Beauffalo's neighbor, Stan, sold Bob the mineral rights to his property but Stan retained title to the land itself. As a result, the land and mineral rights are owned by different people. If Bob were to donate the mineral rights to The Cowboy Museum, a qualified charity, would he receive a charitable deduction?

Yes. Bob's gift of the mineral rights would be a gift of his entire interest. As such, the partial interest rule is not implicated here. Bob can take a charitable deduction provided he completes Form 8283 as part of his tax return and provided he obtains a qualified appraisal.