Yes. Although owners of an oil and gas royalty property did not participate on the risk side of the drilling, the IRS will allow a 15% depletion allowance on the cash flow received. Oil and gas royalty properties are considered a depleting asset11 and it is for this reason that the IRS will allow a 15% depletion allowance on the cash flow, resulting in taxes being paid on 85% of the income received, and is taxed as ordinary income. A year-end tax Form-1099 is issued for the income received.
By comparison, the depletion allowance given on oil and gas royalty properties is similar to the depreciation schedule allowed by the IRS on real estate and brick and mortar assets.
If a royalty property is utilized as a “replacement property11 for an IRC-1031 tax-deferred exchange, then significant tax savings can be realized on the deferral of capital gains tax. This would be an indirect tax benefit connected to the purchase of an oil and gas royalty property.