Royalties are funny things. Generally, we associate royalties with music – and sometimes books. But royalties are bigger than books and music: they are payments for the use of your property. That could be the use of your intellectual property but it could also be the use of your real property. The source of royalty income can run the gamut from copyrights to patents to oil, gas, and mineral properties.
From a tax standpoint, royalties are generally reported to you on a form 1099-MISC at box 2 and are taxable as ordinary income. Interestingly, however, there’s no one size Schedule fits all for royalties. The kind of property determines where you report the royalties – even though the tax rate is the same.
If you hold an operating oil, gas, or mineral interest, you report those on a Schedule C or Schedule C-EZ. Similarly, if you receive royalties from your efforts as a self-employed writer, inventor, or artist, you report those on a Schedule C or Schedule C-EZ. Royalty income reported on a Schedule C or Schedule C-EZ is subject to self-employment income.
Royalties for everything else are reported on Schedule E. Schedule E income is not subject to self-employment income.
Of course, natural resources don’t last forever. In order to account for what happens as you use up resources, you can take a depletion deduction at Part I of Schedule E. You can think of depletion like depreciation: it allows you to recover costs related to the capital you initially contributed. And like depreciation, you have to recapture depletion at the sale of the property.
If you sell your royalty interest, it likely ceases to be treated as royalty income and may be treated as capital gains. Be careful, however, since that will vary depending on the circumstances including the specific asset.
Figuring out royalty income can be tricky. If you receive royalty income (especially royalty income subject to depletion) be sure to consult with a tax professional.
