Attorney General OpinionRuling Addresses Mineral Interests Between Two Counties
On November 26, Attorney General John Cornyn issued Opinion No. JC-0436, addressing property taxation of mineral interests extending across the boundary between two counties. Cornyn held that each county must separately determine the market value of a mineral interest based on the surface land located within that county's boundaries, according to generally accepted appraisal methods.
Cornyn also wrote that if the market value of the mineral interest was uniform across the surface estate, simply determining the market value of the entire mineral interest and allocating that value according to the ratio of surface acreage located in each county may be an appropriate method of appraising the market value of the mineral interest. If, on the other hand, the market value was not uniform across the surface estate, simply allocating the value of the entire mineral interest based on surface acreage was not appropriate, he added.
Both Hockley County Attorney Pat Phelan and Terry County Attorney G. Dwayne Pruitt asked about the proper method for allocating taxable value of mineral interests that straddle the boundary between these two counties. The question concerned taxing a working interest in an oil and gas lease. Eighty-four percent of the surface estate associated with the working interest was located in Hockley County; 16 percent of the surface estate was in Terry County. Two producing wells were located in Hockley County; five were in Terry County. The two sets of wells produced at the same rate. In addition, Terry County asserted that the underlying minerals were not evenly distributed and that the underlying reservoir was more heavily concentrated in Terry County.
A working interest in an oil and gas lease is the interest owned by the operator of the lease who has the exclusive right to exploit the minerals and is usually responsible for all direct operating costs. By contrast, the owner of a royalty interest is entitled to a share of production, generally free of production costs.
In information given to the attorney general, Hockley County Appraisal District (CAD) appraised 84 percent of the value of the mineral interest because 84 percent of the surface estate associated with the mineral interest was in Hockley County. Terry CAD appraised 50 percent of the value of the mineral interest because the district's analysis of present production rates and geological data indicated that 50 percent of the remaining recoverable reserves were in Terry County. Hockley County cited "a fundamental difference" between the appraisal districts, with Hockley CAD valuing the mineral interests created by interests in real property and Terry CAD appraising the minerals under the ground.
The request asked the attorney general whether allocating the mineral interest should "be based: (1) on the ratio of surface acreage covered under the lease attributable to each county, or (2) on an engineering analysis of the reservoir, the production of minerals, and the remaining recoverable reserves present in each county."
The attorney general found that the taxable situs of a working or royalty interest in an oil and gas lease is the location of the surface estate to which the interest appertains. He reviewed court decisions and prior attorney general opinions. In Attorney General Opinion DM-490 (1998), the then attorney general wrote: "Courts have held that because a royalty interest is taxable as an interest in land, it is taxable as real estate in the county where the land to which it appertains is located, rather than in the county where the owner of the interest resides."
Cornyn wrote that Opinion DM-490 was relevant to the request but did not resolve it. That opinion considered royalty interests in a pooled gas unit sharing income from a well located in one school district, but with surface property located in both that school district and another district. Only the school district where the well was located had been taxing the royalty interests. The question was whether a taxing unit was entitled to tax royalty interests based upon the location of the well or based upon the location of surface property. The 1998 opinion concluded that a taxing unit was entitled to assess property taxes based upon the location of the surface property to which the royalty interest appertains.
The current question was not whether each county could tax the mineral interest but how the appraisal district should appraise it in each county. The attorney general concluded that each county was limited to valuing the mineral interest only as it appertains to surface property located in the county. And, he further stated that “each county must appraise the mineral interest as it appertains to surface property located in the county at its market value as of January 1, using generally accepted appraisal methods and techniques. ... The same or similar appraisal methods and techniques shall be used in appraising the same or similar kinds of property. However, each property shall be appraised based upon the individual characteristics that affect the property's market value."
The opinion stated: “In the event, however, that the market value of the mineral interest is uniform across the surface estate, then simply determining the market value of the entire mineral interest and allocating that value according to the ratio of surface acreage located in each county may be an appropriate method of appraising the market value of the mineral interest. This may be the case, for example, if the mineral interest owners have entered into a pooling agreement or some other kind of contractual arrangement that allocates production revenue based on surface acreage, or if the mineral itself is evenly distributed across the surface estate. If, on the other hand, the market value is not uniform across the surface estate, then simply allocating the value of the entire mineral interest based on surface acreage is not appropriate. The appropriate method in that case is to appraise the mineral interest in each county based upon generally accepted appraisal methods. These methods would normally include an analysis of the income to be produced from the mineral interest in the county, which would take into account geological and engineering information such as the productivity of the wells located in the county, reservoir characteristics, remaining recoverable reserves and the likelihood of recovery. ... In this case, the actual location of the mineral is important to the extent it affects the market value of the mineral interest in each county.”
In the opinion, the attorney general reviewed appraisal standards in the Tax Code that provide general directives regarding appraisal methods for determining the market value of taxable property. He referred to Tax Code Section 23.0101, that a chief appraiser "shall consider the cost, income, and market data comparison methods of appraisal and use the most appropriate method.”
The opinion stated that the income approach was generally the most appropriate method for appraising oil and gas interests. In the 1999 case of Destec Properties, Ltd. v. Freestone CAD, the Waco Court of Appeals explained: “[The] 'comparable sales' method of valuing property becomes less accurate when applied to property interests such as an overriding royalty interest [in a mineral] because of the absence of an open market and because the value of the interest lies primarily in its income-producing potential. For this reason, taxing authorities and appraisers commonly turn to the 'income approach' to value when assessing a property interest of this nature.”
In the case of an oil and gas lease, the opinion said that an analysis of the income to be produced from the mineral interest would take into account not just economic data but also geological and engineering information, such as the productivity of the wells, reservoir characteristics, remaining recoverable reserves, and the likelihood of recovery.
The opinion also referred to Tax Code Section 23.175 that provides special rules for the appraisal of a real property interest in oil or gas in place when the appraisal takes into account the future income from the sale of oil or gas to be produced from the interest. This law required the Comptroller by rule to develop and distribute to each appraisal office appraisal manuals that specify methods and procedures to discount future income from the sale of oil or gas from the interest to present value. Each appraisal office must use the methods and procedures specified by these appraisal manuals. The Comptroller has complied with this legislative directive by adopting Comptroller Rule Section 9.4031.
The opinion cited one other provision in the Tax Code dealing with the appraisal of mineral interests — Section 41.455 for a tax protest involving a pooled or unitized mineral interest that is being produced in more than one appraisal district. The opinion found that this provision dealt with the proper procedures to follow when a property owner files a protest rather than how a mineral interest that extends across a county line should be appraised in the first place.