Oil and gas minerals are a depleting asset. When oil or gas comes out of a well, less remains to extract. Also, wells’ rate of output typically declines over time, so royalty checks get smaller (as you have likely seen). That’s a basic reason some people sell. More specific Financial reasons and are expanded on below.
Mineral rights and royalties have real value, but if you only own a small number of properties it is like having all your investments in one stock. Oil and gas is a speculative endeavor, and not just as a commodity price risk. Government regulation and the very real possibility of mechanical problems with your well that could take it out of service for a long period of time are other threats. To mitigate our risk, we own interests in numerous wells in multiple states. People who sell to us often do so because they have all their eggs in one basket, so to speak.
The sale of your minerals would likely be subject to long term capital gains ONLY if you have owned the minerals for more than one year. However, royalties paid to well owners are taxed in multiple ways:
- Federal Income Tax –Up to 39.6%; State Income Tax – Up to 10%;
- State Severance Tax can be as high as 12.5%.
- State Property Tax or Ad Valorem Tax can be as high as 25% of the annual income.
People often choose to get a large upfront check rather than pay these taxes throughout the life of the well.
Monthly checks received from your minerals may not be large enough to help you start a new business or invest in an existing one. A lump sum may fulfill this need where the monthly cash flow does not and create value for your business. Investing in yourself to pursue a new passion or idea is never a bad idea.
Oil & gas wells are depleting assets. A person with a limited portfolio and no means of replacing the declining income or hedging commodity price risk may not fare too well. Production rates decline and there will never be as much in the reservoir tomorrow as there is today. Many people sell their minerals and royalties in order to invest in other assets. Real estate, for example, can offer tremendous upside while paying an income stream. While you may not be able to replicate your income in the near term, over the long term, with price appreciation, you very likely will make out as well or better with a tangible investment that you control.