Is income from dirt pit royalty income

[dlwrightandco]

Client's former tax preparer showed income from fill dirt sold (from a dirt pit) as capital gains income on Schedule D. If any expenses were incurred they were included in the cost. Client has expenses for the dirt pit this year but no income. Where do these expenses go?

[IRonMaN · Accepted solution]

"Client has expenses for the dirt pit this year"

Are they in the business of selling dirt? 

[dlwrightandco]

They sell fill dirt but it isn't the main source of income (they also have a horse farm that doesn't generate much income). In the past they have received 1099-MISC  forms with income listed in the royalty box and also in  miscellaneous income box. For 2018, they had to put in a pipe costing $1164. Should it  on Schedule E as a repair?

[IRonMaN]

I'm certainly not a dirt expert, but I'm trying to figure out how putting in a pipe is related to someone coming in and digging up a pile of dirt.  Does your client do the digging of the dirt or does someone come in with their own equipment and do the digging?

[dlwrightandco]

Unfortunately I do not have all the details. I believe the client does the digging and the pipe was for threshold entry/exit drainage (like a culvert).

[IRonMaN]

If the client does the digging I think you might have moved down one letter in the alphabet from schedule D to schedule C.

[itonewbie]

One thing I learned in this business early on, never assume anything.  It keeps you and your client out of trouble.  And the wrong answer from your client could be a revenue generator.

[itonewbie]

Unless the taxpayer can prove that he/she has no retained economic interest in the minerals (dirt, in this case) and that he/she never depended solely on the sale of the minerals for a return of capital, the income would generally be subject to ordinary tax rates.

It would appear from the little information you provided that your client still has an economic interest in the dirt that has yet to be sold, which means income related to the sale of the dirt is likely ordinary in character instead of capital and could be royalty income.

You should probably look to whether your client is in the business of selling dirt as IRMN says, whether that's minerals extraction, and evaluate the nature of the expenses incurred to determine the proper tax treatment of those expenses (which may or may not require capitalization).