Minerals on Mission: Acceptance and Appraisal
April 28, 2022 - Even before a donor approaches your charity with a gift of mineral interests, you should be prepared to receive such a gift by having acceptance policies in place and understanding the appraisal process.
Charities should have acceptance policies addressing the critical issues that can be triggered by gifts of mineral assets, whether valuation issues, environmental issues, unrelated business income issues, or asset management issues.
Many oil and gas acceptance policies across the country include provisions that:
- Set out a minimum value for gifts of surface rights,
- Set out a minimum per year royalty,
- Provide for review of liability issues,
- Prohibit acceptance of working interests, and
- Provide for environmental review to prevent current or future exposure to environmental liability.
Charities typically do not accept working interests because all liability issues flow to the holder of the working interest. This includes all environmental issues caused by exploration and production of the asset. Royalty interest owners are typically not liable for any environmental conditions which arise during production. By adopting a policy that prohibits any type of mineral gift other than a royalty interest, charities will be safeguarded from the potential consequence of an expensive environmental clean-up.
Another reason to prohibit gifts of working interests is that income derived from working interests is considered unrelated business income and is, therefore, subject to unrelated business income tax.
HighGround’s legal team can provide guidance as you create gift acceptance policies for your organization.
Keep in mind: One charity’s policy might be to sell mineral interests as soon as practical, while another’s might be to hold and manage the mineral interests. Management and administration of oil and gas assets require knowledge and expertise, and charities often obtain third-party managers. We’ll cover this more deeply in our final installment.
Donors who contribute a royalty interest to charity may claim a charitable deduction for the fair market value of the interest if they have held the interest for more than one year. Any contribution that exceeds $5,000 in value must be substantiated by a qualified appraisal. While donors bear the responsibility to obtain a qualified appraisal, it may be helpful for the charity to understand the following guidelines when working with donors:
- Donors who are seeking to gift a mineral interest with a value in excess of $5,000 will need to find a capable appraiser who holds the proper certification and can demonstrate the necessary education and experience needed for this specialized type of appraisal.
- The appraisal must be properly completed in a timely manner and meet all of the IRS requirements for qualification.
- Non-producing mineral interests may be difficult to value, and a contribution of such interests may result in no deduction for the donor.
How does a donor know if their gift’s value exceeds $5,000 and requires an appraisal?
The initial question donors will face is whether the mineral interest’s value necessitates obtaining a qualified appraisal. The general rule of thumb in the oil and gas industry is that the value of a mineral interest will closely approximate the annual income produced by the interest multiplied by a factor of five (annual income x 5). This helpful guideline provides donors with a reliable estimate of the overall value of the interest before incurring the expense of obtaining a qualified appraisal. The formal appraisal will be based upon a more sophisticated estimate of the expected future cash flows and will utilize factors like production history and the number of producing wells, discounted to present value. In any case, the donor will need to talk to his or her advisors about whether and how to get an appraisal.
To sell or retain? That may be the biggest question a charity must face when accepting mineral interests, and that’s what we’ll be covering next.