We certainly have seen an increase in oil and gas activity throughout Northeast Ohio over the past few years. One of the great aspects of oil and gas deals is the flexible structures they offer. Common conveyances include leases, subleases, sales, production payments, sharing arrangements and carried interests.
A lease occurs when a landowner assigns mineral rights and retains a non-operating interest. In a sublease, an operating interest in minerals under lease is assigned and a non-operating interest is retained.
The sale of oil and gas properties can take many different forms. A transaction is treated as a sale if no continuing non-operating interest is retained. The character of the gain or loss on the sale will depend on the type of property.
A production payment is a right to receive a specified amount of the oil and gas revenue for a specified period of time. The expected life of the production payment is shorter than the mineral interest. Carved-out production payments retain a working interest and assign a production payment. Retained production payments keep a production payment and assign a working interest.
Another method used in structuring oil and gas transactions is through tax-free sharing arrangements. Sharing arrangements are used to pool capital into a joint venture for the acquisition, exploration, and development of oil and gas property. Contributors receive an economic interest in the property.
When cash is too short to cover the costs associated with production, carried interests can be used, in which one party agrees to pay another party’s share of costs in exchange for a share of production. The carried party assigns a working interest to the carrier party that agrees to drill, complete and equip the well. The carrier retains a working interest until payout, and reversion may occur anytime after payout.
While the above illustrates the most common deal structures, as the oil and gas industry continues to evolve, innovative financing structures are also emerging. We have seen new, unique types of partnerships and joint ventures being formed to satisfy the growing capital needs of the industry. These carefully planned structures have proven to meet the demands of stakeholders and may open the door to even more options in the future.
Each of these transactional structures will create varying tax opportunities and consequences. Contact a member of your service team to discuss your options.
This communication is for information only, and any action should only be taken after a detailed review of the specific situation and appropriate consultation.
Notwithstanding that these materials do not constitute legal, accounting or other professional advice, as may be required by United States Treasury Regulations and IRS Circular 230, you should be advised that these materials are not intended or written to be used, and cannot be used by you or any other person, for the purpose of avoiding penalties that may be imposed under federal tax laws. No written statement contained in these materials may be used by any person to support the promotion or marketing of or to recommend any federal tax transaction(s) or matter(s) addressed in these materials, and any taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor with respect to any such federal tax transaction matter.
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