Permission to aggregate scattered mineral royalty interests as single properties for depletion

Plain-English summary

The taxpayer is a subsidiary of an international mineral-royalty company that owns passive royalty interests (overriding oil and gas royalties in one region, and gold and other mineral royalties in another) but does not explore, develop, or operate any of the properties. To claim a cost depletion deduction, a taxpayer normally has to compute it separately for each mineral property, but the reserve data needed for that is not available property by property. The taxpayer asked the IRS for permission under Section 614(e) to treat all the scattered nonoperating interests within each of two defined areas as one combined property. Section 614(e) and Treas. Reg. § 1.614-5(d) allow this when the interests sit in adjacent or reasonably close tracts and a principal purpose of aggregating is not tax avoidance. The IRS accepted the taxpayer's representations (adjacent tracts, maps supplied, no tax-avoidance purpose, and no expected change in total depletion) and granted consent to treat the interests in each of the two areas as a single property. The ruling does not opine on how depletion is actually calculated or whether the interests qualify as economic interests.

Ruling snapshot

• Question: May the taxpayer aggregate its separate nonoperating mineral royalty interests within each of two areas and treat each aggregation as one property for depletion purposes under § 614(e)?
• Outcome: Approved
• Key authorities: IRC § 614(e); Treas. Reg. § 1.614-5(d), (e), and (g); Treas. Reg. § 1.614-1 and § 1.614-2

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202044005 Third Party Communication: None
Release Date: 10/30/2020 Date of Communication: Not Applicable
Index Number: 614.04-00
Person To Contact:
----------------- --------------------------, ID No. ----------------
------------------------------ -----------------
-------------------------------------------- Telephone Number:
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-------------------------------------- Refer Reply To:
CC:PSI:B06
PLR-125234-19
Date:
July 31, 2020
Re: Request to aggregate nonoperating
mineral interests

LEGEND:

Taxpayer = ---------------------------------------------------------------------
Corporation = ---------------------------------------------------------------
Holding Company = ---------------------------------------------------------------------------------

Company A = ----------------------------------------
Company B = ----------------------------------------------
State A = ----------
State B = ------------------
State C = -------------
Date 1 = -----------------------
Date 2 = ------------------
Date 3 = ---------------------------
Date 4 = -----------------------
Date 5 = --------------------------
Date 6 = ------------------
x = -----
A = ---------------------------------------------------------------------------------

                                -----------------------------------------

B = -----------------------------------------------------------
Director = ----------------------------------------

Dear ------------:
PLR-125234-19 2

   This letter responds to your request, dated Date 1, as supplemented by letter

dated Date 6, seeking permission to aggregate separate nonoperating mineral interests
under § 614(e) of the Internal Revenue Code (Code) and § 1.614-5(d) of the Income
Tax Regulations (Regulations). The request is submitted with respect to nonoperating
mineral interests held in x mineral properties each separately located in State A and
State B.

   Taxpayer is incorporated pursuant to the laws of State C and is a wholly-owned

subsidiary of Holding Company, which is also incorporated pursuant to the laws of State
C. Taxpayer wholly owns Company A, a limited liability company that is treated as a
disregarded entity for U.S. federal income tax purposes. Company B is a wholly-owned
subsidiary of Taxpayer that was incorporated pursuant to the laws of State C. Together,
Holding Company, Taxpayer (including the activities of Company A), and Company B
are an affiliated group of corporations that file a consolidated U.S. federal income tax
return with Holding Company serving as the common parent. Holding Company is
wholly-owned by Corporation.

    Corporation, along with its subsidiaries identified in this letter and its non-U.S.

subsidiaries, is an international mineral resource and investment company that acquires
mineral, oil, and natural gas royalties and other nonoperating mineral interests
worldwide. Corporation does not explore, develop, or operate on any of the properties in
which it holds interests, relying instead on passive income streams, predominantly
royalties on mineral interests, as the basis of its income. Corporation prepares its
financial statements based on International Financial Reporting Standards as issued by
the International Accounting Standards Board.

   The mineral interests that are the subject of this request are located in the

following areas:

1. A

2. B

The various mineral interests are distinguished and identified according to the area in
which they are located; for illustration, the mineral interests located within area A are
referred to as the A interests.

   For U.S. federal income tax purposes, all the interests described above are

treated as owned by Taxpayer.

   Taxpayer acquired the A interests on Date 2. The A interests consist of

overriding royalty interest in oil and gas producing wells and overriding royalty interest in
acquired leases and the oil and gas from such leases (“ORRI”). Taxpayer does not
have the ability to operate any of the properties in order to produce oil and gas
PLR-125234-19 3

therefrom. The ORRI provides the Taxpayer the right to royalties from the acquired
leases.

   Taxpayer acquired the B interests on Date 3. The nonoperating B interests

consist of gold and other mineral royalty interests including net smelter royalty interests.

    Each production royalty interest held by Taxpayer will be referred to hereinafter

as a “royalty interest.” These royalty interests afford Taxpayer the right to mineral
royalties and do not bear the costs of exploration, development, or production on the
properties. Each of the properties at which the royalty interests are located are operated
by unrelated parties. Furthermore, the interests at each distinct property are located in
tracts of land that are either contiguous, touching at one point (checker-board pattern of
ownership), or reasonably close in proximity to each other. Taxpayer submitted tract
descriptions and a map or maps for each property that shows the total area
circumscribed by each aggregation of nonoperating interests requested by Taxpayer.
Taxpayer considers these interests to be nonoperating mineral interests and has
represented that these interests are nonoperating mineral interests.

   The request seeks the aggregation of the separate nonoperating mineral

interests held at each of the x distinct areas such that the separate interests within each
of the x distinct areas are treated as one property for U.S. federal income tax purposes,
in order to enable Taxpayer to compute their cost depletion deduction in accordance
with §§ 611 and 612 and § 1.611-2. Taxpayer represents the aggregation of the
nonoperating interests at the x distinct areas is necessary to compute cost depletion
because reserve information is not available to Taxpayer on a separate property-by-
property basis. In order to determine the appropriate reserves for each property,
Taxpayer will generally be required to rely on publicly available information and life of
reserve reports provided by the properties’ operators. Taxpayer, and its parent,
Corporation, will rely on the same reserve information to compute book cost depletion in
the aggregate for each of the x distinct aggregations in the preparation of Corporation’s
financial statements and regulatory filings. Granting permission to aggregate the
nonoperating mineral interests at each of the areas into separately aggregated
properties will reduce the administrative burden in calculating depletion and allow
Taxpayer to implement consistent treatment for financial accounting and U.S. federal
income tax purposes.

    Taxpayer represents that a principal purpose of submitting the request for the

aggregation of royalty interests held at each property is not the avoidance of tax.
Taxpayer supports this representation with two justifications. First, the interests subject
to this ruling request do not bear the costs of exploration, development, or production of
the properties. Therefore, it is highly unlikely that the percentage depletion deduction
for each interest would be subject to the taxable income limitation contained in § 1.613-
5, as only general and administrative costs plus any severance and ad valorem taxes
will be allocated to each interest for the purpose of computing the taxable income
limitation. Aggregating the nonoperating mineral interests in the defined areas into x
PLR-125234-19 4

single properties is not expected to alter this result, as no additional percentage
depletion deductions are expected to be allowed if permission to aggregate is granted.
Second, aggregating the interests at each property will not alter the total amount of cost
depletion deductions allowed at each property over its life, as the total cost depletion
deductions allowed for a property cannot exceed the depletable tax basis allocated to
the interests at that property. Accordingly, no cost depletion deductions in excess of
those to which Taxpayer is entitled are expected at each of the x distinct aggregations.

                                 Law and Analysis

   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-125234-19 5

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.

Therefore, to obtain permission, the taxpayer must:

1) Apply for permission within 90 days after the beginning of the first taxable year for
which aggregation is desired, or within 90 days after the acquisition of one of the
properties to be included in the aggregation (section 1.614-5(e)(1)).
PLR-125234-19 6

2) Provide maps, descriptions of the nonoperating interests, and a complete statement
of the facts (section 1.614-5(e)(4)).

3) Establish that the principal purpose for forming the aggregation is not tax avoidance.
A substantial reduction in taxes is evidence that avoidance of taxes is the principal
purpose (section 1.614-5(d) and section 1.614-5(e)).

   Taxpayer represents that the A interests were acquired on Date 2. Pursuant to §

1.614-5(e)(1), Taxpayer has until Date 4 to submit a timely request to aggregate the A
interests. With respect to the interests located at B, Taxpayer represents the B interest
were acquired on Date 3. Pursuant to § 1.614-5(e)(1), Taxpayer has until Date 5 to
submit a timely application to aggregate the B interest. This request was filed on Date
1.

    Taxpayer represents that to the best of Taxpayer’s and its representatives’

knowledge that each of the interests identified and located at each of the x distinct
areas are “nonoperating mineral interests” as that term is defined in § 1.614-5(g), and
that the interests are interests that do not bear the costs of exploration, development, or
production. Taxpayer also represents that to the best of Taxpayer’s and its
representatives’ knowledge that the interests at each property are owned in two or more
tracts or parcels of land that are “adjacent” or “in reasonably close proximity to each
other” as provided in § 1.614-5(d). Additionally, Taxpayer represents that to the best of
Taxpayer’s and it representatives’ knowledge that the maps for each property included
with the ruling request demonstrate that the nonoperating interests at each distinct area
are in reasonably close proximity to each other, as these interests are either contiguous,
touch at a corner, or are separated by intervening mineral rights but included in a single
operating mineral interest.

  Taxpayer represents that an abandonment loss on any aggregated nonoperating

mineral interest will not be taken until all the mineral rights in the entire aggregated or
combined distinct properties are proven to be worthless or until the entire aggregated or
combined distinct properties is disposed of or abandoned pursuant to § 1.614-6(d).

   Lastly, Taxpayer represents that to the best of Taxpayer’s and its

representatives’ knowledge that the principal purpose of forming the requested
aggregation at each property is not tax avoidance. The purpose of forming the
requested aggregation is to reduce administrative burden in calculating depletion and
allow Taxpayer to implement consistent treatment for financial accounting and federal
income tax purposes

   Based on the representations made and consideration of the descriptions and

maps submitted, we conclude that the requirements of § 1.614-5 have been met.
Based solely on the facts and representations submitted, we grant consent for Taxpayer
to aggregate the separate nonoperating mineral interests located at the x distinct areas,
PLR-125234-19 7

A and B, such that the nonoperating mineral interests located at A and B are separately
treated as a single property for U.S. federal income tax purposes.

   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. Specifically, we express or imply no opinion
concerning Taxpayers’ calculation of depletion or whether Taxpayers’ interests in the
properties are economic interests. This ruling is conditioned on each royalty interest
qualifying as an economic interest under § 611 before the aggregation. General
descriptions of the nonoperating interests accompanied by maps are to be on file with
the books and other records that are necessary for examination by the Service.

  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.

   This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)

of the Code provides it may not be used or cited as precedent. In accordance with the
power of attorney on file with this office, a copy of this letter is being sent to your
authorized representatives. We are also sending a copy of this letter to the Director.
Pursuant to § 1.614-5(e)(4), a copy of this letter must be attached to the taxpayer’s
federal income tax return for the first taxable year for which such permission applies. If
Taxpayer has already filed such return, a copy of the letter of permission must be filed
with the Director and must be accompanied by an amended return or returns if
necessary or, if appropriate, a claim for credit or refund.

  This letter ruling is being issued electronically in accordance with Rev. Proc.

2020-29, 2020-21 I.R.B. 859. A paper copy will not be mailed to Taxpayer.

                                      Sincerely,



                                      Patrick S. Kirwan
                                      Branch Chief, Branch 6
                                      Office of Associate Chief Counsel
                                      (Passthroughs & Special Industries)

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