PROPERTY TAX VALUATION FOR OIL AND GAS MINERAL RIGHTS

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By Amish Gupta – COO, RETC

When we hear the term “real estate,” we often think of office buildings, retail centers, multifamily, hospitality/hotels, or industrial-manufacturing facilities. Rarely do we think of the oil and gas industry. However, real estate and the oil and gas industry do overlap, specifically in regard to mineral rights. The valuation of these mineral rights is similar in nature with the real estate classes mentioned above. As such, mineral right accounts face many of the same challenges, with respect to property tax, as any other income-producing property—including the potential for double assessment.

With income-producing property, the tax burden falls on the owner, but with the valuation of mineral rights, the property tax burden falls primarily on the oil and gas operator. Oil and gas companies acquire leases, meaning they are granted exclusive rights to explore and develop minerals on the property for a set period of time. In the state of Texas, these mineral rights fall under the real estate classification for property tax purposes. Although oil and gas terminology differs drastically from the more commonly known real estate properties, the valuation and assessment is derived in a similar nature.

In Texas, a majority of the county appraisal districts outsource the oil and gas/mineral right accounts to third-party appraisal companies. These companies typically have more resources and are specialized in valuing mineral right accounts. As opposed to working with the local assessor, operators and property tax consultants work primarily with the third-party appraisal groups to provide and receive information to help derive a value for the mineral right accounts.

Oil and gas mineral right accounts are valued on the income approach, much like that of other income-producing properties. The most distinct difference is the method used, which is the discounted cash flow model. Essentially, the mineral rights are valued using the estimated cash flows from the estimated remaining life of the well which are then discounted back to a present value for the current year’s valuation.

The key factors affecting the value are production, expenses and depletion percentage, often called percentage of decline or decline curve. In addition, the status of the well can play into the valuation. If a well is shut in or not currently producing oil, temporarily or permanently abandoned, a stripper well or non-producing for any other reason, the valuation of the mineral rights may be impacted causing a reduction in the value or assessed value for a particular oil and gas lease.

Properties like those in the oil and gas industry that are valued-based on the income produced from their business often times run the risk for double assessment. In Texas, business personal property, or tangible fixed assets not permanently attached to the land or improvements, is taxable in addition to the real estate. The hospitality industry faced the double assessment issue for many years until recently, when the property tax code was changed to help reduce the potential for double assessment.

Businesses are required to file a list of business personal property utilized in their company. However, when a property is valued using the income approach, it encompasses all assets, both real and personal, to derive income, similar to that of the hospitality industry as previously mentioned. Often times, oil and gas companies are required to file a business personal property tax return for those assets above ground separate from the mineral rights. This may consist of piping, tanks, compressors, etc.

To ensure they are not double assessed, oil and gas companies need to give close attention to those mineral right leases where both a property tax return is required to be filed for the above-ground assets and the mineral rights are valued on a separate account. The only acceptable scenario for separate assessments on two accounts for the above-ground assets and mineral rights is when the mineral right account being valued using the income approach is reduced by the value of the above-ground assets being assessed on the business personal property tax account. Otherwise, your business is more than likely being double assessed.

Whether you own real estate in the hospitality industry, office building, retail centers, industrial facilities, or oil and gas mineral rights, owners should ensure their properties are being fairly and accurately assessed. Knowing how property values are derived and areas to focus on when reviewing values are critical steps. Based on conversations with multiple appraisal districts, values are expected to increase significantly this assessment year, and property owners need to ensure their potential value increases are reflective of their business and the overall market.