IRS permits aggregation of two related net profits interests

Plain-English summary

The IRS granted a taxpayer permission to aggregate two aggregate net profits interests in mineral properties and treat them as one property for federal income tax purposes. The taxpayer represented that the interests were single economic interests, that the properties were in the same or adjacent tracts, and that the aggregation was sought to reduce the cost and burden of separate accounting. The IRS concluded that avoiding tax was not a principal purpose of the aggregation. The resulting combined interest must be treated as one § 614 property beginning in the specified year and thereafter unless the taxpayer obtains consent to change the treatment.

Ruling snapshot

• Question: Could the taxpayer aggregate two related aggregate net profits interests under § 614(e) and Treas. Reg. § 1.614-5(d)?
• Outcome: Approved, for the specified taxable year and subsequent years
• Key authorities: IRC §§ 613 and 614; Treas. Reg. §§ 1.614-1, 1.614-2, and 1.614-5

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201405002 Third Party Communication: None
Release Date: 1/31/2014 Date of Communication: Not Applicable
Index Number: 614.04-00
Person To Contact:
----------------------------------- --------------------------, ID No -----------------
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----------------------------------- Telephone Number:
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-------------- Refer Reply To:
------------------------------------- CC:PSI:B06
PLR-117056-13
Date:
October 22, 2013

LEGEND

Taxpayer = ------------------------------------------------------------
Partnership = --------------------------------------------------------------------------
Date 1 = -----------------------
Date 2 = ------------------
a = -----
b = ----
c = --
d = --
A = ----------------------------------------------------------
B = ----------------------------------------------------------
C = ------------------------------------------------------------
e = --------
f = --------
g = ----
h = ----
i = --
j = --
k = --
l = ----
m = --
n = ------
o = --------

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

This letter replies to a letter, dated Date 2, in which Taxpayer requests permission to
aggregate certain aggregate net profits interests pursuant to § 614(e) of the Internal
Revenue Code and § 1.614-5(d) of the Income Tax Regulations, effective Date 1.
PLR-117056-13 2

The facts and representations submitted are summarized as follows:

Taxpayer, a calendar year, accrual basis taxpayer, owns producing and nonproducing
mineral, royalty, overriding royalty, net profits and leaseholds interests in approximately
a counties and parishes in b states. A substantial part of Taxpayer’s assets consists of
aggregate net profits overriding royalty interests that burden various properties owned
by Partnership, which is owned (directly and indirectly) by Taxpayer’s general partner.
Taxpayer receives monthly payments from Partnership based on the net profits
Partnership actually realizes from the properties burdened by Taxpayer’s aggregate net
profits interests.

Taxpayer owns c aggregate net profits interests, d of which, A, B, and C, are relevant to
this ruling request. A, the largest aggregate net profits interest, burdens properties
located in various oil and gas properties throughout the United States. B, the second
largest aggregate net profits interest, burdens properties located in various regions of
the United States. Lastly, C, the smallest aggregate net profits interest, burdens
multiple properties in the United States. Taxpayer represents that each of A, B, and C
is a single economic interest that constitutes a single property for purposes of § 614.

Taxpayer represents that substantially all of the properties burdened by C are also
burdened by A (“over-lapping properties”). The remainder of the properties burdened
by C are also burdened by B (non-overlapping properties). C burdens approximately e
properties, approximately f of which are over-lapping properties. Although the other
approximately g non-overlapping properties are not burdened by A, Taxpayer
represents that they either are adjacent to or in close proximity to properties burdened
by A.

Taxpayer further represents that each of the g non-overlapping properties is located in
reasonably close proximity to a property burdened by A. Each of the non-overlapping
properties is in the same county as a property burdened by A. Additionally, of the g
non-overlapping properties, (i) h are contiguous with properties burdened by A, (ii) i
are located within j miles of a property burdened by A, (iii) k are located between j and l
miles of a property burdened by A, and (iv) m are located between l and n miles of a
property burdened by A. Thus, o% of the total properties burdened by C are located
within l miles of a property burdened by A.

Both the properties burdened by A and the properties burdened by C historically have
generated positive net profits. Taxpayer expects that these properties will continue to
generate positive net profits in the future. Separately accounting for A and C is time
consuming and expensive. Accordingly, Taxpayer desires to aggregate A and C to
reduce the time and expense required to separately account for the two aggregate net
profits interests. Taxpayer represents that the aggregation of A and C will not result in a
substantial reduction in tax.
PLR-117056-13 3

The aggregation of A and C would be accomplished by amending the terms of the
conveyance creating A such that, following the amendment, A would burden both the
properties currently burdened by A and the properties burdened by C. As a result, in
determining the amount payable with respect to A, the total income from the properties
currently burdened by A and the properties burdened by C would be offset by the total
expenses of the properties currently burdened by A and the properties burdened by C .
Thus, following the aggregation, there would be a single computation for all of the
properties currently burdened by A and C.

In the case of mines, wells, and other natural deposits, § 614(a) and § 1.614-1(a)(1)
define the term “property” to mean each separate interest owned by the taxpayer in
each mineral deposit in each separate tract or parcel of land.

Section 1.614-1(a)(2) 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,
production payments.

Section 614(e)(1) 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) and § 1.614-5(g) 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.

Section 1.614-2(b) defines the term “operating mineral interest” to mean a separate
mineral interest as described in § 614, in respect of which 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) provides that upon proper showing to the Commissioner, a taxpayer
who 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, shall be permitted,
under § 614(e), 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
PLR-117056-13 4

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) 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 1.614-5(e)(4) provides that the application for permission to aggregate
nonoperating mineral interests under § 614(e) 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 aggregation and shows that the
taxpayer is aggregating all the nonoperating 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 such 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) provides that the election to aggregate separate nonoperating
mineral interests under § 614(e) and § 1.614-5(d) is binding upon the taxpayer for the
first taxable year for which made and for all subsequent taxable years unless consent to
make a change is obtained from the Commissioner.

A net profits interest that burdens multiple properties (aggregate net profits interest) is
treated as a single economic interest that constitutes a single property under § 614(a) if
the burdened properties are economically interrelated. That is, in computing the
amount owed to the holder of the aggregate net profits interest, the holder of the
burdened working interests must take into account the revenues and expenses from all
PLR-117056-13 5

of the burdened properties. The holder of an aggregate net profits interest must at all
times look to all the burdened properties for a return of capital. Therefore, an aggregate
net profits interest must be created and conveyed in a single transaction and all the
burdened properties must be identified at the time that the net profits interest is created
and conveyed. The addition of properties to an aggregate net profits interest after it is
created, except as permitted under § 614(e), is an impermissible aggregation that
disqualifies the aggregate net profits interest as a single economic interest.

If an aggregate net profits interest qualifies as a single economic interest, a single § 614
property, a net profits interest that burdens a working interest in the same tract or parcel
of land as any one of the working interests burdened by the aggregate net profits
interest would be considered to be in the same tract or parcel of land as the aggregate
net profits interest for purposes of the aggregation rules of § 614(e) and § 1.614-5(d).
Moreover, a property that is adjacent to, that is, in reasonably close proximity to, any
one of the properties burdened by the aggregate net profits interest would be adjacent
to the aggregate net profits interest.

Thus, under § 614(e) and § 1.614-5(d), a taxpayer that owns an aggregate net profits
interest that qualifies as a single economic interest, may request permission to
aggregate the aggregate net profits interest with a separate net profits interest that
burdens a working interest in the same tract or parcel of land as any one of the working
interests burdened by the aggregate net profits interest. Similarly, a taxpayer that owns
an aggregate net profits interest may request permission to aggregate the aggregate
net profits interest with a separate net profits interest that burdens a property that is
adjacent to any one of the properties burdened by the aggregate net profits interest. In
either case, permission to aggregate is granted only if the taxpayer establishes that a
principal purpose in forming the aggregation is not the avoidance of tax.

Taxpayer has represented that each of A, B, and C is single economic interest that
constitutes a single property for purposes of § 614. Taxpayer also has represented that
substantially all of the properties burdened by C are in the same tracts or parcels of land
as certain properties burdened by A, or in tracts or parcels of land that are adjacent to
properties burdened by A. Finally, Taxpayer has represented that the purpose of the
proposed aggregation is to eliminate the hardship and expense of separately
accounting for the separate aggregate net profits interests, and that the proposed
aggregation will not result in a substantial reduction in tax.

Based on the representations made and consideration of the descriptions and maps
submitted, we conclude that the avoidance of tax is not a principal purpose of forming
the aggregation. Based solely on the facts and representations submitted, we grant
consent for Taxpayer to aggregate A and C. The aggregate net profits interest resulting
from the aggregation of A and C must be treated as a single property for purposes of
§ 614 for the taxable year beginning Date 1, and for all subsequent tax years, unless
consent is obtained from the Commissioner to change the aggregation.
PLR-117056-13 6

Except as specifically set forth above, we express or imply no opinion concerning the
federal income tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. In particular, we express or imply no opinion whether each of
A, B, C, or the aggregate net profits interest resulting from the aggregation of A and C is
a single economic interest that qualifies as a single property under § 614. This ruling is
conditioned on each of A, C, and the aggregate net profits resulting from the
aggregation of A and C qualifying as a single economic interest under § 614.

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 representative. We also are 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,
                                         Associate Chief Counsel
                                         (Passthroughs and Special Industries)



                                         Brenda M. Stewart
                                         Senior Counsel, Branch 6
                                         Office of Associate Chief Counsel
                                         (Passthroughs & Special Industries)