PORTFOLIO

Mineral Properties Other Than Gas and Oil — Operation (Portfolio 603)

Tax Management Portfolio, Mineral Properties Other than Gas and Oil — Operation, No. 603-3rd, analyzes the tax aspects of the operation and ownership of mineral properties other than oil and gas. The definition of mineral properties includes nonmetals such as clay, coal, and limestone, and metals such as iron, lead, and zinc. Although this Portfolio does not cover oil and gas properties, many of the basic tax concepts governing oil and gas properties apply to mineral properties and are therefore discussed. Likewise, cases and principles applicable to mineral properties frequently apply to oil and gas.

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DESCRIPTION

Tax Management Portfolio, Mineral Properties Other than Gas and Oil — Operation, No. 603-3rd, analyzes the tax aspects of the operation and ownership of mineral properties other than oil and gas. The definition of mineral properties includes nonmetals such as clay, coal, and limestone, and metals such as iron, lead, and zinc. Although this Portfolio does not cover oil and gas properties, many of the basic tax concepts governing oil and gas properties apply to mineral properties and are therefore discussed. Likewise, cases and principles applicable to mineral properties frequently apply to oil and gas.


This Portfolio examines the concepts which are of paramount importance in the tax treatment of mineral properties, including: (1) the definition of “property” as set forth in §614 for various tax purposes; (2) the concept of “economic interest”; (3) the §614 principle of “aggregation”; (4) the §611 depletion allowance, including cost depletion under §612 and percentage depletion under §613; (5) the election under §617 to expense or capitalize mining exploration expenditures; (6) the election under §616 to expense or capitalize mine development expenditures; (7) the special treatment afforded dispositions of coal and domestic iron ore under §631(c); (8) the tax treatment of miscellaneous mineral payments; and (9) mineral classification.


In addition, the Portfolio summarizes the tax aspects of bonuses, advance royalty payments, and delayed rentals; various tax principles affecting mineral properties such as the alternative minimum tax; the special rules for mining and solid waste reclamation and closing costs; and the mining-related tax credits.


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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. Introduction

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. Property

A. Definition of Property

1. Evolution of the Term “Property”

2. Each Separate Tract or Parcel of Land

3. Impact of Transfers with Carryover Basis

4. Each Separate Deposit

5. Effect of Blanket Royalties

B. Impact of Change in Character of a Mineral Property Interest

C. Impact on Cost Depletion

D. Impact on Abandonment Losses

E. Definition of Minerals and Mining

F. Aggregation and Deaggregation Rules

1. Aggregation of Operating Interests

2. Operating Mineral Interests Defined

3. Operating Unit Defined

4. Impact of Reacquired Interests: Merger under Local Law

5. Aggregation of Nonoperating Interests

a. Nonoperating Interests

b. Aggregation

6. Special Rules for Operating Mineral Interests

7. Deaggregation

8. Procedural Aspects of Elections

9. Procedure for Change of Election

10. Supporting Documents for Aggregation or Deaggregation Election

11. “Mine” for Purposes of Elections to Aggregate or Deaggregate

12. When Election to Aggregate Is Effective

13. Impact of Aggregation on Basis

14. Limitation on Losses on Aggregated Properties

IV. Depletion

A. History

B. Cost Depletion

1. First Element - Basis

2. Second Element - Recoverable Units

3. Minerals Consumed in Course of Production

4. Futures Contract as Basis for Depletion

C. Percentage Depletion

1. Gross Income from the Property

a. In General

b. Transportation

c. Agents and Captive Mines

d. Receipts Not for Minerals - No Percentage Depletion

e. Treatment of Royalties, Ad Valorem Taxes and Selected Miscellaneous Payments

f. Black Lung Excise Tax Payments

g. Historical Background to Definition of Mining Processes

h. Mining Processes

(1) General Rules

(2) Necessary and Incidental Processes

(3) Specific Applications

(4) Nonmining Processes

i. Bonus Exclusion Rule

2. Allocations of Gross Income to Mining and Nonmining Activities

a. General

b. Representative Market or Field Price

c. Proportionate Profits Method

d. Alternative Methods

3. Mining Deposits of Waste or Residue

a. Background

b. Bulk Dispositions of Tailings

c. Natural Deposit Versus Waste

4. Taxable Income from the Property

a. Background

b. Loss Capitalization Rule and Production Payments

c. Allocating of Overhead and General Expenses

d. Allocating Costs Between Mining and Nonmining

e. Abandoned Geological and Geophysical Costs as Overhead

f. Equipment Abandonment Losses

g. Business Interruption Insurance Costs

h. Depreciation of Withdrawn or Idle Equipment

i. Damages for Nonproduction

j. Bond Repurchase Premium

k. Repairs and Receding Face Expenditures

l. Deduction of Other Expenditures Under the Receding Face Doctrine

m. Reduction of Corporate Preferences

n. Net Operating Losses

o. Impact of Aggregation

p. Depreciation Recapture

D. Recapture of Percentage Depletion on Disposing of Mineral Property

E. AMT Effect of Percentage Depletion

V. Exploration and Development Expenditures

A. Exploration Expenditures

1. Basic Rules

2. Recapture of Exploration Expenditures

3. Recapture of Exploration Expenditures on Disposition of Property

4. AMT Effect

5. Mandatory Capitalization

6. Section 1254 Recapture of Mine Exploration and Development Expenditures

7. Restrictions on Nonrecourse Development

8. Revocation of Exploration Deduction Election

B. Development Expenditures

1. In General

2. Foreign Exploration and Development Expenses

VI. Disposal of Minerals Other Than Coal or Domestic Iron Ore with a Retained Economic Interest

A. Sale Versus Lease: Historical Reasons for Differing Tax Treatment

B. Sale-Versus-Lease Principles

C. Leases

1. Generally

a. Background

b. General Rules

c. Retained Net Profits Interest

d. Retained Production Payments

2. Difficulties in Distinguishing Sales and Leases of Mineral Interests

a. Background

b. Retention of a Minor Nonworking Interest

c. Series of Options

d. Production as Source of Payment of Purchase Price

D. Summary

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

A. Legislative History

1. Coal Royalties

2. Domestic Iron Ore Royalties

B. Statutory Requirements of § 631(c)

1. Overview and Application

2. Contract-Related Administration Expenditures

3. Holding Period Test

a. Basic Requirements

b. Legislative Background

c. Successors in Interest

d. When Holding Period Begins

4. Ownership Test

5. Disposition Test

a. General

b. Bonuses

c. Availability of Rulings

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

C. Section 631(c) Transactions Between Related Taxpayers

D. 1984 Deficit Reduction Act Amendments to § 631(c)

E. S Corporations and Built-in Gains Tax

VIII. Miscellaneous Mineral Payments

A. Bonuses

1. Bonus Restoration Rule

2. Lapse of Option to Lease

3. Transfer of Bonus

B. Advance Royalties

C. Restoration of Deductions to Income on Abandonment

D. Delay Rentals

1. In General

2. Selection Bonus as Delay Rental

3. First Year Rentals

4. Assignment of Right to Delay Rental

5. Shut-in Royalty

E. Lessee Versus Contract Miner Status

IX. Mineral Classification

A. Percentage Depletion Rates

B. Definitions

1. United States

2. Natural Deposit

3. Quartzite

4. All Other Minerals

5. Dimension Stone

6. Natural Deposits and Solution Mining

7. Peat and Moss

8. Oil Shale and Other Petroleum-Bearing Solids

9. Steam and Geothermal Deposits

10. Soil and Dirt

11. Minerals from Inexhaustible Sources

12. Water and Cost Depletion

X. Depreciation and Cost Recovery

Introductory Material

A. Methods Available

1. Background

2. Unit-of-production Method

3. Accelerated Methods - Pre-1986 Act

4. 1986 TRA Revision of ACRS to MACRS

a. General

b. Classification of Property

c. Alternative Depreciation System and Foreign Property

B. Effect of Aggregation

C. Change of Method

D. Election to Expense Advanced Mine Safety Equipment

XI. Alternative Minimum Tax

XII. Uniform Capitalization Rules

XIII. Export of Mineral Properties

Introductory Material

A. DISC Provisions

B. FSC Provisions

C. Extraterritorial Income Exclusion

XIV. Special Rules for Mining and Solid Waste Reclamation and Closing Costs

A. Background

1. Pre-1984 Act Rules

2. Legislative Background to 1982 Changes

B. Overview

1. General Explanation of § 468

2. Effective Dates

3. Relationship to Brownfields Deduction

C. Detailed Analysis of § 468

1. Election of Current Deduction

a. Election and Amount of Deduction

b. Deductible Costs

2. Rules Governing Reserves

a. Additions to Reserve

b. Deductions from Reserve

c. Limitation on Reserve Balance

3. Recapture of Reclamation and Closing Cost Deductions

XV. Black Lung Benefits Tax

Introductory Material

A. Base Taxable Coal

B. Unavailable Excise Tax Exemptions

C. Meaning of “Producer”

D. Exempt Coal

1. Lignite

2. Imported Coal

3. Exported Coal

E. Use as a Basis for Liability for Tax

F. Deduction of Black Lung Excise Tax

XVI. Abandoned Coal Mine Reclamation Fee

XVII. Domestic Production Activities Deduction

A. In General

B. Application to Minerals Industry

XVIII. Mining Related Tax Credits

A. Credit for Producing Fuel from a Nonconventional Source

1. Background

2. Detailed Discussion

a. Synthetic Fuel

b. Coke and Coke Gas

c. Calculating the Credit

d. Qualifying Facilities

e. Related-Party Rules

B. Coal and Gasification Credits

1. Qualifying Advanced Coal Project Credit

a. In General

b. Definitions

c. Certification and Allocation of Credits

2. Qualifying Gasification Credit

a. In General

b. Definitions

c. Certification and Allocation of Credits

d. Recapture of credits

C. Coal-Related Credits Under Section 45

1. Credit for Producing Electricity from Co-firing Coal and Biomass

a. In General

b. Computation of Credit

c. Definitions

d. Limitations

2. Refined Coal Production Credit

a. In General

b. Computation of Credit

c. Definitions

(1) Refined Coal

(2) Steel Industry Fuel

d. CREB Financing

3. Indian Coal Production Credit

a. In General

b. Computation of Credit

c. Definitions

D. Mine Rescue Team Training Credit

XIX. Operations on Indian Lands


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Effect of Aggregation With Percentage Depletion Only

Worksheet 2 Effect of Aggregation of Properties With Both Cost and Percentage Depletion

Worksheet 3 Effect of Aggregation of Properties With Cost Depletion Only

Worksheet 4 Depletion Computation With Sales After Extraction

Worksheet 5 Ad Valorem Reclamation Fee Computation

Worksheet 6 Mining Contracts

Worksheet 7 Rev. Proc. 74-43, 1974-2 C.B. 496 Alternative Method to Compute Gross Income from Mining

Worksheet 8 Rev. Proc. 66-11, 1966-1 C.B. 624 Guidelines for Computing Cost Depletion Deductions by Taxpayers Who Extract Ground Water

Worksheet 9 Rev. Proc. 64-23, 1964-1 C.B. 689 Determination of Operating Unit in the Case of Oil and Gas Properties

Worksheet 10 Rev. Proc. 78-19, 1978-2 C.B. 491 Definitions of Mining Terms

Worksheet 11 Rev. Proc. 77-11, 1977-1 C.B. 568 - Conditions for Issuance of Rulings as to Whether Bonuses and Advanced Royalties Qualify for Section 631(c) Treatment

Worksheet 12 GCM 22730, 1941-1 C.B. 214

Worksheet 13 Renewable Electricity Production Credit Tables

Worksheet 14 Nonconventional Fuels Credit Tables

Worksheet 15 Section 325 of the Revenue Act of 1951

Worksheet 16 H.R. Rep. No. 1337, 83d Cong., 2d Sess. 59, 60, A189-191 (1954), House of Representatives Ways and Means Committee Report to Accompany H.R. 8300

Worksheet 17 S. Rep. No. 1622, 83d Cong., 2d Sess. 80, 81, 337–339 (1954), Senate Finance Committee Report to Accompany H.R. 8300

Worksheet 18 H. R. Rep. 2543, 83d Cong., 2d Sess. 53, 54 (1954), House–Senate Conference Report to Accompany H.R. 8300

Worksheet 19 Summary of H.R. 8300. Summary of New Provisions of Internal Revenue Code of 1954 as Agreed to by the Conferees, Prepared by the Staff of the Joint Committee on Internal Revenue Taxation 80, 81 (1955)

Worksheet 20 H. R. Rep. No. 749, 88th Cong., 1st Sess. 93, 94, A133, A134 (1963), Report of the Committee on Ways and Means, House of Representatives, to Accompany H.R. 8363

Worksheet 21 Staff Description of H.R. 8363, the Revenue Act of 1963, as Passed by the U.S. House of Representatives, Prepared by the Staff of the Joint Committee on Internal Revenue Taxation and Printing for the Use of the Committee on Finance 91 (1963)

Worksheet 22 S. Rep. No. 830, 88th Cong., 2d Sess. 119–121 and 253, 254 (Part 2) (1964), Supplemental Report of the Committee on Finance, United States Senate, to Accompany H.R. 8363

Worksheet 23 H.R. Rep. No. 1149, 88th Cong., 2d Sess. 47 (1964), House-Senate Conference Report to Accompany H.R. 8363

Worksheet 24 Section 631 - Gain or Loss in The Case of Timber, Coal, or Domestic Iron Ore [As Amended by the Tax Reform Act of 1984 (P.L. 98-369)]

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Committee Reports:

Treasury Rulings:

Cases:

UNOFFICIAL

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