IF I OWN MINERAL RIGHTS CAN I DO A 1031 EXCHANGE?
There are several types of oil, gas and mineral rights (hereinafter collectively referred to as “minerals”). A mineral estate is the perpetual interest in all the minerals in or on the land. The mineral rights can be sold as a whole (separate from the fee interest) but frequently they are divided into lesser interests such as mineral leases, mineral royalties and production payments.
To summarize, a mineral lease and mineral royalty are considered real property for federal tax purposes and may be eligible for a 1031 exchange; whereas, a production payment is not like kind to real estate and is not eligible for 1031 treatment.
Whether a mineral lease is eligible for 1031 treatment depends on whether the party is the lessor or the lessee. Since a mineral lease is an interest in real property, the lessee can receive the mineral lease as replacement property in the 1031 exchange after selling an interest in other real property. Because the lessor retains a royalty interest (but does not convey the entire real estate interest) the mineral lease is not eligible for 1031 treatment for the lessor. However, the lessor can subsequently sell the entire royalty interest and do a 1031 exchange with the proceeds.
Exchanges involving mineral interests, mineral leases and mineral royalties can be very beneficial for land owners by allowing them to better utilize the value of their asset. Let’s assume that Bob Jones farms or ranches a tract of land. Bob can sell his mineral rights (or royalty interest) without selling the fee to the property, do a 1031 exchange and acquire, as replacement property, additional acreage to farm or ranch or acquire other income producing property which can supplement his income or prepare for his retirement.
In addition, the replacement property could be a mineral lease or mineral royalty interest in a different property. All of this can be achieved legally without paying taxes. In addition to benefitting land owners, 1031 exchanges can be beneficial to companies that own mineral leases and/or mineral royalty interests. A company can reposition its assets by selling mineral leases and exchanging them for other mineral leases or mineral royalty interests. The sale of mineral leases may also involve the transfer of equipment and other tangible personal property. By doing a multi-asset exchange they can defer paying taxes on any depreciation recapture as well as any appreciation of the lease interest.
Although the applications are numerous and the process of doing a 1031 exchange does not need to be complicated, taxpayers are always advised to seek the advice of competent tax and legal advisors.
We, at IPX1031®, pride ourselves on not only being the industry leader in service and security, but we also strive to help our clients and their advisors keep current on tax issues pertaining to §1031 exchanges. We aim to be a valued information resource. For more information about us or our complimentary monthly webinars about 1031 exchanges, please visit our website at www.ipx1031.com.