1031 Exchange - Turn Your Mineral Rights Into an Investment Property
Updated: Feb 4, 2019
As previously discussed in earlier blog posts, there are many variables to consider when deciding whether to sell your minerals. I’m here to tell you about a lesser-known benefit of selling your mineral interests that could help keep your investment growing- something called a 1031 Property Exchange. Also known as a “like-kind exchange”, you essentially swap your mineral rights for a similar real estate property, and the benefit you receive is not owing taxes at the time of exchange, or deferral. In essence, you are changing the form of your investment, without recognizing it as a capital gain and therefore not paying taxes on it until a later date. This is great news for any mineral owner who is looking for a new form of investment.
In many cases, mineral rights can be exchanged for traditional real estate investments such as ranches, rental properties, or even commercial centers. Say for instance you were thinking about selling your mineral or royalty interest to Tower Rock, and we made you an offer too good to turn down. Instead of pocketing the money from the sale, you could then invest the earnings into a new, higher earning real estate property. There is no limit on the number of times you can make a 1031 exchange, so you could technically do this as many times as you want. You will only owe taxes when you decide to make a cash sale years down the road, instead of investing in another like-kind property. When you do eventually decide to sell, this would likely be taxed at a long-term capital gain rate, as long as the asset had been held for over a year, which is typically below the regular tax rate.
So what’s the catch?
While there is no catch, there are a few rules and exceptions. Here they are:
• If one of the properties being exchanged is a depreciable property, a gain known as “depreciation recapture” may come into effect.This would be taxed as ordinary income and takes place to account for the depreciation you’ve already claimed on the depreciating property and to thereby reclaim it. This is an instance when it’s necessary to have a professional help you.
• You can’t make a swap for a property that you personally use.For example, you cannot trade your mineral rights (an investment) for a new home that you will live in (personal). A 1031 is for investments only. You can, however, swap your mineral rights for a piece of land, a building, etc. “Like-kind” is a loosely used term as long as the properties follow the rules.
• There’s a timeline that the IRS requires for this nontaxable event to occur. You must both identify the replacement property within 45 days and close on this new property within 6 months of the sale of the old property.
Other resources on 1031 exchanges:
Internal Revenue Service- Oil & Gas Handbook https://www.irs.gov/irm/part4/irm_04-041-001-cont02.html#d0e6197
Mineral Wise- The Tax Deferring Advantages of 1031 Exchanges for Mineral Rights https://www.irs.gov/irm/part4/irm_04-041-001-cont02.html#d0e6197
Investment Property Exchange Services, Inc.- If I Own Mineral Rights Can I Do a 1031 Exchange? https://www.ipx1031.com/fb/April2012-InsiderExtra2.htm
This information provided is for informational purposes only and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional accountant. We strongly urge you to consult a tax and/or finance professional that can provide you advice specific to your situation.