Can the Section 1031 exchange be used for mineral rights? Contrary to commonly held beliefs, yes—it can be used to exchange mineral rights in most cases. There are, however, a few things you should be aware of, especially time limits and the types of limitations that may render a mineral rights lease ineligible for the Section 1031 exchange. Read below to learn about Section 1031 exchanges as they relate to mineral rights.
- Section 1031 exchanges are a tool designed to allow you to exchange one investment property for another without paying capital gains or other taxes on the sale of the original property.
- It’s commonly held that Section 1031 exchanges aren’t available for mineral rights—but mineral rights leases are considered a type of real estate interest, which means that in fact, many mineral rights contracts are eligible for a section 1031 exchange.
- Purchasing mineral rights, futureproofing your purchase to ensure its eligibility for a future 1031 exchange, and completing a 1031 exchange are all complex processes with a lot of nuances and regulations involved—which is why it’s best to handle these transactions with an experienced firm that can help you avoid pitfalls along the way.
What is Section 1031?
Section 1031 is part of the IRS tax code. A Section 1031 exchange allows you to exchange one investment property for another. Most of the time, investment exchanges are taxed just like sales—but if your investment exchange meets the requirements that Section 1031 sets forth, then you can reduce or eliminate taxes due when you make the exchange.
The benefit to doing a Section 1031 exchange is that tax deferral. This allows you to change your investment vehicle without cashing out or creating a situation in which the IRS would require you to pay capital gains taxes.
1031 Exchanges for Mineral Rights
Broadly, the definition for 1031 exchanges covers things like real estate investments: raw land, homes, hotels, multifamily dwellings, commercial properties, retail properties, farmland, oil fields, and so on. This leads some to believe that 1031 exchanges cannot be used for mineral rights—but the 1031 exchange can be used for mineral rights.
Technically, leases on mineral rights are considered a real estate interest, which makes mineral rights eligible for the 1031 exchange. However, certain terms of a mineral lease might render it ineligible. In general, limitations on the amount of minerals allowed to be extracted through the mineral lease may affect whether mineral rights are eligible for a 1031 exchange.
Nuances to Know
To successfully complete a 1031 exchange, there are a few nuances to be aware of. These exchanges are classified as “like-kind,” a phrase that can be misleading. In this instance, “like-kind” doesn’t necessarily mean that you must trade your investment for an exactly similar investment, like exchanging between land investments. Rather, this term applies to investment and business property, which means you can exchange rental property for retail property, or exchange undeveloped land for a commercial building.
Another thing to understand about Section 1031 exchanges is that you can do them as many times as you like—but all gains that you make during the exchange must be rolled over into the new investment. In this way, your profits remain untaxed until you sell the investment for cash, at which point you’ll need to pay the one-time long-term capital gains tax.
Considerations for a 1031 Exchange
One of the key things to consider when doing a 1031 exchange is a type of exchange structure you may use. This is important because the different structures each have different deadlines.
Most commonly, 1031 exchanges use what is known as the delayed, forward, or three-party structure. With this structure, an intermediary holds the cash from your sold investments and uses that cash to buy the new investment. Intermediaries are necessary to hold the cash, otherwise, it will fall outside the terms of the 1031 exchange, which makes you liable for taxes.
This structure has two important deadlines. The first is that you must designate a replacement property of investment for your intermediary to purchase within 45 days of the sale of your initial investment. This time allotment is what makes this structure so popular—very rarely are investment properties available for a simultaneous exchange. The other deadline comes 180 days after the sale of your initial investment property. Closing on your new investment property must happen within that 180-day window, otherwise, your reinvestment will be ineligible for the Section 1031 exchange.
Another type of exchange structure is the simultaneous exchange. This one isn’t as common as delayed exchanges because it requires the disposition of your sale property and the purchase of the new, like-kind property to happen at the same time—a difficult feat to manage.
There is also what is known as the reverse exchange. This is also a rather uncommon situation, but it is a structure you can use when you need to purchase your like-kind replacement property before you can sell your initial property to a buyer. This type of exchange comes with a variety of additional rules and regulations surrounding it, and because of its complexities, it’s best handled with experienced legal counsel.
Buying Mineral Rights with Eckard Enterprises
Purchasing mineral rights can be an excellent investment—and it’s one best done with the guidance and experience of a firm like Eckard Enterprises. There are a lot of rules, regulations, and nuances involved, which means expertise will help you avoid potential pitfalls. Few firms have the kind of experience with 1031 exchanges that Eckard does. We have worked with Exeter 1031 Exchange, cohosting webinars on these topics and more.
What this means is that when purchasing mineral rights through Eckard Enterprises, we can help you ensure that your contract will potentially be eligible for a 1031 exchange should you ever decide to sell parts of your real estate portfolio for mineral rights.
The Bottom Line for Your Money
Mineral rights are a great investment tool. If you’re interested in selling real estate so that you can invest some of your real estate portfolio in mineral rights, the 1031 exchange is an instrument to help you reinvest that money without paying taxes. Before you purchase mineral rights, however, it is wise to lay the initial groundwork for the future by ensuring that your mineral rights will be eligible for the 1031 exchange program.
Ready to learn more about available opportunities to invest in mineral rights? Contact Eckard Enterprises, and we’ll be happy to walk you through the options and answer any questions you may have.