How to 1031 Exchange Oil, Gas and Mineral Interests into Mineral Rights & Royalties

In the world of oil and gas, there is a lot of industry jargon that may seem intimidating, redundant, or confusing for first time investors. However, if you were involved in any part of the process for finding, extracting or selling valuable resources, then you may find yourself with mineral interests in your portfolio.

Oil, gas and mineral interests can be extremely valuable, leading to high profit margin sales to interested buyers. In order to lower the amount of taxes paid on these sales (often a significant amount), you can use a 1031 exchange. With this in mind, mineral rights and royalties are a great way to reinvest, as they provide the partial or total ownership of a property’s mineral rights. In this article, we will fully define all of these terms and explain how to use a 1031 exchange to get the most on your investment.

What are Oil, Gas and Mineral Interests?

Okay, first let’s start by defining an oil, gas or mineral interest. To put it simply a mineral interest is the right of a person to access and operate on a property to move an oil or gas operation forward. Mineral interest owners are often compensated for their part in the production with lease bonuses and one time payments.

For a more detailed look on the different kinds of oil, gas, and mineral interests, feel free to read our article on royalty interests for oil and gas.

How to Sell Oil, Gas and Mineral Interests

To initiate a 1031 exchange, you will first need to find a buyer for your mineral interests. Oil, gas, and mineral interests and be sold, traded or gifted on the open market, just like any other kind of private property. Many professional networks exist to help fairly and quickly exchange mineral interests among qualified personnel.

Determining the Value of Oil, Gas and Mineral Interests

There are essentially no limits on the value of oil gas and mineral interest as profitable resource operations become increasingly more and more sought after. For the most part, the value of oil and gas mineral interests are a reflection of past sales with similar properties.

The value of individual oil and gas mineral interests is determined by:

  • Oil and Gas Lease Terms
  • Reserve Volume and Property Size
  • Number of Interested Parties
  • Time Left in Current Contracts
  • Property History and Future Projections

Mineral interest exchanges are not mandated to be public record, however many past transactions can be found if the companies you are working with are transparent in their business operations. As an additional rule of thumb, mineral interests should never be sold to the first potential buyer. If one person is interested, chances are many more will be as well.

Taxes Paid on the Selling Oil, Gas and Mineral Interests

Unfortunately, private transaction for the sale of mineral interests results in fairly serious taxation from the federal and local governments. Before selling your mineral interests, be sure to consider taxes paid on the sale. In some cases, the benefits of keeping the interests may outweigh the net financial gain.

For most transactions, mineral interests sales have the following applied:

  • Federal Income Taxes
  • Capital Gains Taxes
  • Sales Taxes
  • Local Taxes
  • And More
  • Thankfully, many expenses associated with finding and transferring ownership to new buyers can be deducted from the sale of mineral interests on your yearly taxes. To completely eliminate capital gains tax, a 1031 exchange can be used when purchasing a similar property.

Selling Oil, Gas and Mineral Interests with a 1031 Exchange

1031 exchanges are an IRS-sponsored process in which capital gains taxes can be completely eliminated from the sale of oil, gas, and mineral interests. In order to happen, taxpayers must “trade-up” for a new property shortly after selling the original interests.

Oil, Gas and Mineral Interests Like Kind Properties

Although you may not think of them this way, mineral interests can be viewed just as any other ordinary property in the eyes of the IRS. After selling your mineral interests, a 1031 exchange can be used to purchase any of the following, capital gains tax free:

  • Mineral Rights and Royalties
  • Water and Ditch Rights
  • Farms
  • Commercial Businesses
  • Surface Rights
  • Malls
  • And More

Self Storage Facilities 1031 Exchange Timeline

After the sale of oil, gas, and mineral interests, a taxpayer then has 1031 days to purchase a new like kind property with a 1031 exchange. In order to keep the process moving forward, the first of three potential properties must be purchased within 45 days of the original sale.

1031 Exchange Intermediaries for Selling Oil, Gas and Mineral Interests

Identifying properties, processing paperwork, and meeting deadlines can be difficult if you are using a 1031 exchange while maintaining your usual schedule. Thankfully, there are many industry professionals that can help you with each part of the process along the way.

In most cases, it is extremely beneficial to speak with both a 1031 exchange tax professional and mineral interest expert. If one person or company happens to fit both of these qualifications, then the process may be even easier.

Why Purchase Mineral Rights and Royalties?

The biggest difference between mineral interests and mineral rights is the time period and investment potential. Mineral interests are temporary and will expire at the end of any oil and gas lease. Whereas they can possibly be renewed, assets with an expiration date are often better sold then kept.

Mineral rights can lead to ongoing mineral royalties for the extraction and sale of valuable resources. Once a lease has ended, you will still retain your mineral rights, which can be sold or leveraged once again for another oil and gas lease.

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