I've been getting a lot of questions concerning the implications of selling a royalty interest.  A reread of the Louisiana Mineral Code and a discussion with my O&G attorney convinces me I need to correct some prior statements in regard to how such sales are taxed and how they may be structured.  The following is amended text to the appropriate section of my Mineral Fundamentals blog.

"A mineral right or royalty interest may be sold in its entirety or as a fraction of the whole.  One of the four owners of an undivided interest in our 40 acre example, owning 10 net mineral acres, would have the right to sell a half interest in their mineral right.  This would result in their retaining a one eighth ownership interest in each of the gross 40 acres and the buyer owning a one eighth interest in each acre.  If the seller's mineral right was burdened by an existing mineral lease the buyer's mineral interest would be subject to the terms of that lease.  If the 10 acres was un-leased or an existing lease expired then both seller and buyer would be free to lease, or not, their separate ownership interest going forward.   A royalty interest may be sold in its entirely or as a fraction of the whole.  A mineral right owner has the right to lease their interest, receive royalty, bonus and other payments. A royalty interest owner has only the right to receive their proportional share of the royalty. As defined by the Louisiana Mineral Code, there are two classes of royalty:  a royalty created from a mineral right and a royalty created under an Oil, Gas & Mineral lease.  A royalty created from a mineral right, whether by the owner of the lands or by the owner of a mineral servitude created from the lands, is effective for a defined period of time no greater than ten years.  If there is no production during the prescriptive period the mineral right royalty expires.  If production is established the prescriptive period is suspended at that point and begins again from day one when production ceases. 

A royalty created under an Oil, Gas & Mineral Lease is effective for the term of the lease.  Whenever the lease expires, whether through failure to drill a well or through the drilling on a non-producing well, the royalty  created under that lease expires also.   If a producing well or wells are drilled then the lease remains in force, as does the royalty created from it, until such time as production ceases.   Unlike a mineral servitude created by the sale of a mineral right, the prescriptive period for a royalty created under a lease is not reset by a good faith effort to produce that fails (i.e., a dry hole).

I strongly advise mineral owners who wish to sell a royalty interest to engage the services of an experienced energy attorney.  There are various ways that a royalty may be defined in a conveyance instrument that determine how it is interpreted in law.  For the practical purposes of a willing seller the most important variance is how the proceeds of a sale are taxed.  The sale of a royalty created from a mineral right, owned for a period greater than one year under current IRS rules, is taxed as long term capital gains.  Depending on the seller's tax bracket that would be either 15% or 20%.  The proceeds of a sale of a royalty created under an Oil, Gas & Mineral Lease would be taxed as "ordinary income" and depending on the amount would be taxable up to the top effective rate, currently 39.6%.  Louisiana mineral owners would also pay the appropriate percentage of state tax in addition to their federal tax requirement.  Offers to acquire a royalty interest in producing minerals are commonly based upon a multiple of a monthly average payment.  As an example a buyer of royalty may take the average of the most recent three monthly payments and then multiply that amount by a number of months of production, commonly 60 to 120, to calculate their dollar offer."

A royalty interest created from a mineral right may qualify for tax advantages as long term capital gains.  I'm getting some comments from members that they sold their royalty only for five years or some other specific time period.  As you can see that is easily misconstrued.  If production is established during the effective period the royalty interest remains in force through the entire period of production regardless of how long that may be.  It is unclear to me whether those individuals and companies currently purchasing royalty interests created from a mineral right are making a good faith effort to fully explain the facts of the transaction.  Interested sellers should seek counsel from an experienced O&G attorney.