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ISSUES INVOLVING PAYMENTS TO SURFACE OWNERS IN CONNECTION WITH OIL AND GAS DRILLING ACTIVITIES by ProQuest

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Many current oil and gas leases contain clauses obligating the operator to compensate the surface owner for losses such as crop damages, damages to land and structures, and diminished value. Classifying payments received from operators as damages is generally the most tax-favorable classification, since damage payments associated with capital assets such as land are not taxable until the basis of the property to which the payments pertain is recovered. The excess in most cases is taxed at favorable capital gain rates. Damage payments, however, must be made for current provable damages and not for future possible damage to property. The burden of proof in determining the nature of the payments is on the taxpayer. Taxpayers wishing to apply non-recognition treatment of payments for "damages" should provide their tax professional with appropriate documentation.

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