If you've earned money from a well this year, you may have questions about how to calculate your net revenue interest (NRI) on your 2020 tax return. Your NRI is the share of oil or gas production that's calculated once burdens have been deducted from your working interest. Here's a snapshot of what the revenue life cycle looks like:
- A well has both a working interest owner and overriding royalty owner attached to it.
- The well owner will get a flat percentage of proceeds from the well.
- The other owner(s) will get what's known as working interest.
Basics of Determining NRI
When determining NRI, you're subtracting royalties from the top to divide what remains among all working interest owners. Once that flat royalty fee is paid, the overriding royalty owner won't get additional cuts of revenue. The working interest that you receive for the well is based on what remains after royalties.
An Example of How to Calculate Your NRI for Oil and Gas
Let's say that royalty rights account for 20 percent of revenue right from the start. You'll need to subtract 20 percent from 100 percent to be left with 80 percent. In this case, that 80 percent is the NRI for the entire production site. If the site is divided between multiple parties, it's necessary to drill down further to find the NRI for each individual party; however, that 80 percent stands if you are the sole producer.
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In most cases, there will be at least one other person with working interest. Let's assume there's another holder who holds 10 percent of the working interest of your well. That means that you're now holding 90 percent of the 80 percent from the full working interest side that remains after royalties. In this case, you'll figure that 90 percent x 80 percent = 72 percent, and this means that your NRI is 72 percent for the well.
This can get exponentially more complex if you are the owner of working interest that is part of a much larger operation. However, the general rule is to always figure out your percent of the percent that is left over after royalties, regardless of how many owners are dividing the post-royalty NRI. Some agreements may specify that different holders get different percentages.
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Why Overriding Royalty Owners and Mineral Rights Owners Are Different
An overriding royalty owner is considered a passive party in this equation. They do not take on any costs associated with drilling or operating a well. They essentially provide consent and access for a well.
By contrast, a working interest owner funds the costs associated with generating revenue from a well. This can include costs related to drilling the well, exploring the well, developing the well, operating the well and maintaining the well. In addition to paying royalty costs, an overriding royalty owner may owe revenue portions to financial backers who provide funding in exchange for percentages of revenue generated from oil production.
While a person who receives royalties from living on a well property can report the income fairly easily, anyone with NRI should consider working with an accountant specializing in mineral rights.
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- Overriding royalty interest owners do not bear the cost of drilling or operating a well.
- The working interest owner bears the expense of oil (or gas) exploration, development and well operation. In exchange, he receives a share of the proceeds of the well after royalties have been paid.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.