How to Claim Gas Lease Income on a Federal Tax Return

Lease income gets special depletion write-offs.

Lease income gets special depletion write-offs.

If you have a gas lease on your property that provides you with income, the money you make is taxable. The IRS requires you to report it on a special form -- Schedule E -- and allows you to subtract your expenses from it. Once you've calculated your net income, you then pay regular income tax on it.

Income Types

Gas leases can produce a few different types of income. Royalty payments, which are your share of the value of the gas that the driller pulls out of your property, get reported on the "Royalties received" line of the Schedule E form. If you receive lease payments, these go on the "Rents received" line. Lease payments can come in the form of a bonus, usually agreed to upfront to compensate you for signing the lease. You might also get "delay rental" payments that pay you while the drilling company has the right to use your land but is not yet drilling or extracting gas. You might also get lease payments for other rights that you give the drilling company, such as the ability to put pipelines on or in your land.

Allowed Expenses

The Schedule E form also lets you write off any expenses that you incur in receiving gas lease income. If you aren't actively involved in running the drilling and extraction operation, your primary expense will typically be depletion. The IRS lets you write off a percentage of your income every year against your royalties as a way of making up for the gradually decreasing value of your land as the gas gets taken out. This reduces your taxes.

Income from Sales

If you sell your gas lease property, the IRS will tax your profits as a capital gain. As long as you've owned it for one year or more, you will qualify for long-term capital gain treatment on your profit. However, you will also have to pay depletion recapture tax on the difference between your depleted price and your original cost basis, assuming that you sell it for your cost basis or more. This happens because you got to write down the value of your investment for being depleted and. If you sell it for more than the depleted value, the IRS wants the write-off it back.

Income vs. Business

The rules for your gas lease income are a bit different if you're actually involved in running the drilling business as opposed to just getting payments from a third party that is doing the heavy work. If you're taking an active interest in running the well, you get to write off more expenses. You will also have to file Schedule C instead of Schedule E and pay self-employment tax on your income.

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