EXCHANGES OF OIL, GAS AND MINERAL INTERESTS

Oil, gas and mineral interests are real estate interests which qualify for a like-kind exchange with any other qualifying real estate interest including -
- A fee interest in real estate
- Fractional ownership interests
- 30+ year leasehold interests
- Other oil, gas and mineral interests
- Conservation easements
- Transferable development rights
- Right-of-way easements
- Water rights
- Mutual irrigation ditch stock

A mineral interest is a perpetual interest on all of the minerals on a parcel of land including oil and gas, coal, gold, sand, gravel, water, etc.

There are several different kinds of ownership of oil, gas and mineral interests which include –
- Mineral rights which are a part of fee ownership of the ground.
- Mineral rights which are owned separately from ownership of the ground.
- A mineral lease granted to a lessee by the owner of the mineral rights.
- A royalty interest which can be viewed as a form of rent received by the lessor of the mineral rights.

A mineral lease gives the lessee the right to extract the mineral for a period of time, or until exhaustion of the mineral. Mineral leases are sometimes referred to as a working interest or an operating interest. The lessee is the operator who is extracting the mineral. A mineral lease can be subleased to other operators.

An exchange of a working or operating interest might include equipment or other tangible personal property which would need be viewed as a multi-asset exchange (more than one kind of property).

A production payment is a right to the mineral in place for a specified sum of money, payable out of a specified percentage of the mineral production. It is a “carved out production payment” and is not considered real property for exchange purposes.

Depletion expense can be deducted by the owner of an operating or royalty interest. There are two types of depletion: percentage depletion and cost depletion. Taxpayers use the method that yields the highest deduction.

Intangible drilling costs are operating costs to extract the mineral. Costs for fuel, preparation of a site, and wages are examples of intangible drilling costs.

Mineral property exchanges may be subject to recapture under Section 1254 if deductions were taken for depletion or intangible drilling costs on the relinquished property. The replacement property must be both like-kind and natural resource recovery property (Section 1254 property) to avoid recapture.

Call us at 888-37-1031 or email us at 1031@1031cpas.com if we can help with any questions. See our Exchange Manual at http://www.1031cpas.com/. 1031 Corporation is the Intermediary of Choice for thousands of real estate professionals, CPAs and investors.

Development Rights are Like Kind to Fee Interest in Real Estate

A newly released private letter ruling, PLR 200901020, reaffirms the IRS's view that development rights are a qualifying interest in real estate which can be like kind to a fee and other interests in real estate for purposes of an exchange under IRC Section 1031. PLR 200805012 previously affirmed the same. Accordingly, development rights can be exchanged for a fee interest in real estate and vice versa.

In order for development rights to be like kind to fee interest in real estate under IRC Section 1031, it is necessary for the state the rights are located in to view such rights as a real estate interest and for the rights to be in perpetuity (as distinguished from rights which are short-term or for a limited period of time). Perpetuity is important. Short-term rights may be an interest in real estate under state law but are not like kind to a fee interest in real estate under IRC Section1031. PLR 200901020 makes this clear.

A qualifying interest in real estate which can be like kind to a fee interest in real estate under IRC Section 1031 can include varying types of real estate interests. PLR 200901020 examines such other types of qualifying interests in real estate including –

• Leasehold interests of 30 years or more
• Easements
• Rights-of-ways
• Water rights
• Mineral rights
• Royalty rights
• Mineral leases

All of these types of real estate interests are considered like-kind to each other under IRC Section 1031 and may be exchanged for each other.

While the privage letter ruling can not be cited as precedent, and the IRS has the right to rule differently on subsequent occasions, it is a useful ruling for the purpose of demonstrating the IRS's view for similar situations. To receive a copy of the PLR, give us a call at 888-367-1031 or send us a message at 1031@1031cpas.com.

Oil, Gas and Mineral Interest 1031 Exchanges

It would seem to make sense that you could exchange a working or royalty interest for another working or royalty interest as part of a 1031 Exchange. But, did you know that you can also exchange a working or royalty interest for other real estate? For example, if you sell a working interest, you could replace it with another working interest, a royalty interest, or ownership in an office building, apartment building, or other real estate.

However, oil, gas and mineral interest exchanges are tricky. For example, if you sell a working interest and retain the royalty interests or surface rights, the IRS may disallow your exchange. This is because production payments do not qualify for a 1031 Exchange.

The sale of working interests often involves the sale of related equipment. Keep in mind that transfers of equipment require the equipment to be treated as a separate personal property exchange. Personal property exchanges are a different animal than real estate exchanges.

Also note that any costs incurred to drill and develop the gas or mineral site must be recaptured to the extent that you do not re-acquire qualified natural resource property. In other words, if you sell a working interest in a gas well and buy an office building, you would have to "recapture" the Intangible Drilling Costs (IDC) costs you had previously deducted.

If you have questions about Oil, Gas or Mineral interests and how they relate to 1031 exchanges, please contact 1031 Corporation Exchange Professionals at 888-367-1031.