PORTFOLIO

Mineral Properties — Exploration, Acquisition, Development and Disposition (Portfolio 601)

Tax Management Portfolio, Mineral Properties — Exploration, Acquisition, Development and Disposition, No. 601-4th, explains the nature of exploration, analyzes the methods of acquiring mineral properties and the different types of interests that may be held therein, reviews the determination of the basis of assets that are acquired, defines the term “development,” describes the proper income tax treatment of development costs, and describes the ways of disposing of mineral properties or interests therein and the tax consequences that attach to each type of disposition.

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Tax Management Portfolio, Mineral Properties — Exploration, Acquisition, Development and Disposition, No. 601-4th, explains the nature of exploration, analyzes the methods of acquiring mineral properties and the different types of interests that may be held therein, reviews the determination of the basis of assets that are acquired, defines the term “development,” describes the proper income tax treatment of development costs, and describes the ways of disposing of mineral properties or interests therein and the tax consequences that attach to each type of disposition.

The Portfolio also discusses the origin and nature of the “economic interest” concept, a key element in determining the entitlement to depletion deductions and in characterizing both the nature of the transaction when mineral property is disposed of and the tax treatment of the consideration received in the transaction. The Portfolio discusses the extensive litigation in this area, and some of the guidelines for determining who are considered as possessing the economic interest in various types of transactions. It also distinguishes between operating and nonoperating economic interests and describes the various types of nonoperating economic interests and the resulting tax consequences.


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AUTHORS

RICHARD A. WESTIN
Richard A. Westin, B.A., Columbia University (1967); M.B.A., Columbia University (1968); J.D., University of Pennsylvania Law School (1972); Member, Kentucky Bar Association, Tax Bar Association, Court of Claims, Tax Court; Distinguished University Professor, University of Kentucky College of Law; Foundation Professor, University of Houston Law Center (1993–1999); Visiting Professor, University of Tennessee Law School (1983–84); Associate Professor, Chicago-Kent College of Law (1979–83); Former Consultant to Legal Department of International Bank for Reconstruction and Development, Washington, D.C.; Research Fellow at University of Dundee, Petroleum and Mineral Law Centre (1992); Author, 601 T.M., Mineral Properties — Exploration, Acquisition, Development and Disposition; RIA Tax Dictionary (2006–present); Taxation of International Electronic Commerce) (2d ed. 2008); Federal Income Taxation of Natural Resources (with F. Murray PLI 1994); Taxation for Environmental Protection, a Multinational Study (with Gaines, Tiley, Erikkson, Von Zezchewitz and Hertzog) (1991); Basic Federal Income Taxation (Aspen Law d Business 2002); Taxation of Business Enterprises (with Parejo and Beck VandePlas 4th Ed. 2012).

TABLE OF CONTENTS

Detailed Analysis

I. Key Terminology

II. Economic Interest Concept

Introductory Material

A. Definition

1. Significance and Origin

2. Acquisition by Investment

3. Interest in Minerals in Place

4. Income from Severance and Sale of Minerals

5. Income Secured by Legal Relationship

B. Historical Development

1. Introduction and Background

2. Supreme Court Cases Analyzing Economic Interest

3. Court of Federal Claims Decisions

4. Other Significant Authorities

a. Cases

b. Revenue Rulings

III. Exploration

A. Introduction

1. The Nature of the Activity

2. Current Statutory Framework

B. History of Tax Law Treatment of Exploration Expenditures Up to 1976

C. Pre-1977 Tax Rules for Election to Deduct or Defer Expenditures

1. Election to Expense Exploration Costs

2. Effect of Deferral

3. Predecessor's Election

4. Effect of Prior Law Option Exercised to Defer on Adjusted Basis

D. Tax Reform Act of 1986 Amendments

1. Overview

2. Exploration and Development Costs

a. Domestic Costs

b. Foreign Costs

c. Gain on Disposition of Interest

E. Current Tax Provisions

1. Tax Planning Significance of Depletion

2. Accounting for Exploration

a. In General

b. Reconnaissance Surveys

3. Optional Treatments of Exploration Deductions

a. Section 59(e) Election Alternative

b. Election to Expense Exploration Costs

(1) Making Election

(2) Revocation of § 617(a) Election

(3) Effect of § 617(a) Election

(4) Limitation for Foreign Exploration Costs

4. Definition of Exploration Expenditures

a. In General

b. Particular Items That Have Been Held to Qualify or Not Qualify as Exploration Deductions

c. Relationship to Otherwise Deductible Items

d. Relation to Geological and Geophysical Expense Deductions

5. Exploration and Development Deductions Claimed by Carried and Carrying Party

6. Effect of Predecessor's Deductions

7. Recapture of Deducted Expenses

a. Options upon Reaching the Producing Stage

b. Default Result

c. Election to Report Adjusted Exploration Expenditures in Income

(1) Definition of “Adjusted Exploration Expenditures”

(2) Manner of Making the Election

d. Upon Receipt or Accrual of Bonus or Royalty

e. Upon Sale or Other Disposition of Property - Impact of § 617 Before 1987

8. Recapture Under § 1254 for Post-1986 Dispositions

9. Relation to Loss Carryback and Carryover

10. Tax Planning for Exploration Expenditures

a. In General

b. Alternative Minimum Tax and Corporate Preference Reduction Considerations

(1) History

(2) Basic Computation

(3) Exploration and Development Expenditures as AMT Preferences

(4) Depreciation and Depletion as AMT Preferences

(5) Corporate Cutback of Exploration and Development Expenditures and AMT Effect

(a) Cutback of Deductions

(b) AMT and Regular Tax Impact of Cutback on Mining Exploration Expense Preference

IV. Development

A. Definition

B. Methods

C. Tax Provisions

1. Current Deduction of Development Expenditures

2. Election to Defer Development Expenditures

a. Effect of Election

b. Manner of Making the Election

c. Entitlement to the Election

d. Deduction of Amounts Deferred

e. Scope of § 616(b) Election

f. Carved-Out Production Payment to Acquire Machinery

3. Transition from Exploration to Development

4. Producing Stage Defined

D. Cost Incurred for Another's Benefit - Carried Interests

E. Seller's or Lessor's Development Costs

F. Deduction of Other Expenditures Under the Receding Face Doctrine

V. Acquisition and Basis of Mineral Properties

A. Introduction

B. Acquisitions of Economic Interests by Contributions of Services or Assets

1. Introduction

2. Pool of Capital Doctrine

3. Production Payments Carved Out for Development

4. Contract Mining Situations

C. Lease and Bond Agreements

D. Basis Allocations and Capitalized Operational Costs

E. Loss from Failure to Acquire Lease

VI. Depletion of Mineral Properties

A. General

B. Depletion of Operating Interests

C. Depletion of Nonoperating Interests

1. Election of Lessor to Defer Development Costs

2. Apportionment of Depletion Among Payees

3. Coal and Iron Ore Royalties

4. Allowable Depletion

5. Bonuses and Advance Royalties

VII. Dispositions

A. Sales

1. General

2. Recapture Under § § 1245 and 1250

3. Recapture of Exploration and Development Expenditures on Disposition of Property

a. Exploration

b. Development

4. Recapture of Percentage Depletion on Disposing of Mineral Property

a. General Rules

b. Numerical Examples

5. Capital Gain and § 1231 Treatment

6. Allocation of Purchase Price Between Mineral Property and Equipment

7. Sale of a Royalty

8. Sale of a Bonus

B. Leases and Subleases

C. Disposition of Coal and Iron Ore Under § 631(c)

1. Legislative History

a. Coal Royalties

b. Domestic Iron Ore Royalties

c. Relationship to Personal Holding Company Income

d. Withholding on Payments for Foreign Persons

2. Statutory Requirements of § 631(c)

a. General

b. Impact of Nonelective Nature of § 631(c) on Subleasing and Options

3. Contract Related Administration Expenditures

4. Holding Period Test

a. Basic Requirements

b. Legislative Background

c. Successors in Interest Defined

d. When Holding Period Begins

5. Ownership Test

6. Disposition Test

a. Bonuses

b. Related Party Transactions

c. Availability of Rulings

7. Distinctions Between Surface and Mineral Ownership Under § 631(c)

8. Section 631(c) Transactions Between Related Taxpayers

9. The Deficit Reduction Act of 1984 Amendments as to Related Taxpayers Under § 631(c)

VIII. Lease vs. Mining Contract

A. General

B. Separately Operated Interests

C. Factors to Consider in Distinguishing Mere Contractors from Holders of Economic Interests

D. Planning for Contract Miners with Supply Contracts

E. Captive Mines

IX. Sale vs. Lease

Introductory Material

A. Standard Definition of a Lease

B. Development of the Sale vs. Lease Issue

X. Distinction Between Operating and Nonoperating Interests

XI. Various Types of Nonoperating Interests

Introductory Material

A. Basic Royalty

B. Overriding Royalty

C. Lease Bonus

1. Taxation of Recipient and Payor

2. Bonus Restoration Rule

D. Deduction for Advance Royalties

1. Taxation of Payor and Recipient - In General

2. Lapse of Option to Lease

E. Delay Rentals

F. Production Payments

1. General

2. Pre-1969 TRA Case Law

3. Tax Reform Act of 1969

a. General

b. Carved-Out Production Payments

(1) General

(2) Exception for Production Payments Carved Out for Exploration and Development

c. Retained Production Payments

(1) General

(2) Retained Production Payment on Sale of Mineral Property

(3) Retained Production Payment in a Leasing Arrangement

G. Carried Interests

H. Restoration of Deductions to Income on Abandonment

XII. Aggregation of Nonoperating and Operating Interests

Introductory Material

A. Nonoperating Interests

B. Operating Interests

XIII. Disposition of Nonoperating Interests

XIV. Losses on Nonoperating Interests

XV. Dispositions of Operating Interests

XVI. Like-Kind Exchanges of Mineral Interests

XVII. Domestic Production Activities


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Treatment of Exploration Costs Under § 617 (with Tables)

Worksheet 2 Sample Contracts and Contract Provisions

Worksheet 3 Sales Distinguished from Leasing Contracts

Worksheet 4 Staff of Joint Committee on Taxation, H.R. 3838, 99th Cong., 2d Sess., General Explanation of the Tax Reform Act of 1986 (“The Bluebook”), 195–203 (1987)

Worksheet 5 Rev. Rul. 69-262, 1969-1 C.B. 166

Worksheet 6 Rev. Rul. 70-287, 1970-1 C.B. 146

Worksheet 7 Rev. Rul. 70-288, 1970-1 C.B. 146

Worksheet 8 Rev. Rul. 70-289, 1970-1 C.B. 147

Worksheet 9 Rev. Rul. 77-188, 1977-1 C.B. 76 1

Worksheet 10 Rev. Rul. 83-46, 1983-1 C.B. 16

Worksheet 11 Rev. Rul. 83-105, 1983-2 C.B. 51

Worksheet 12 Rev. Rul. 90-20, 1990-1 C.B. 117

Worksheet 13 Sample Election to Defer Development Expenditures Under § 616(b)

Worksheet 14 Sample Election to Expense Exploration Costs Under § 617(a)

Worksheet 15 Sample Election to Report Exploration Costs in Income Under § 617(b)

Worksheet 16 Excerpt from IRS Market Segment Specialization Paper (MSSP), Placer Mining Industry, Training 3147-121 (7/99)

Bibliography

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Statutes:

Regulations:

Committee Reports:

Treasury Rulings:

Cases:

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