Deferral of capital gains, depreciation recapture, and potentially the 3.8% Net Investment Income Tax and Alternative Minimum Tax (AMT), resulting in lower taxation on other income.
1031 Exchange Into
1031 Exchange Advantages
A 1031 exchange allows for immediate tax deferral, but its real value lies in its ability to support a variety of short- and long-term investment and business goals, including:
Property Types Commonly
Exchanged in 1031
Qualifies
Farms, vacant land, office buildings, rentals, industrial properties, shopping centers, oil and gas rights.
Does Not Qualify
Personal-use properties, property held for sale, partnership interests, stocks, and bonds.
Key Timing Rules for 1031 Exchanges
45-Day Rule
The first rule requires identifying a replacement property within 45 days of selling your property. The intermediary, who holds the proceeds from the sale, must receive your designation of the replacement property in writing. Receiving the sale proceeds yourself would disqualify the transaction from 1031 treatment. You may name up to three properties, with the option to identify more if they meet certain valuation requirements.
180-Day Rule
The second rule pertains to the closing of the replacement property. You must close on this new property within 180 days of the original property’s sale. These periods overlap, so if you designate a replacement on the 45th day, you’ll have 135 days remaining to close on it.
Reverse Exchange
It’s also possible to purchase a replacement property before selling the original one. The 45- and 180-day windows still apply, requiring the new property to be transferred to an exchange accommodation titleholder, and a property identified for exchange within 45 days. The transaction must be completed within 180 days of buying the replacement.
1031 Exchange Tax Implications: Cash and Debt
If you have cash remaining after acquiring the replacement, the intermediary will pay it to you after 180 days. This “boot” will be taxed as a capital gain. Additionally, you must consider any debt on the original and replacement properties; if your debt decreases, the difference is considered income and taxed accordingly. For example, if the mortgage on your old property was $1 million, but the new one is $900,000, you’ll incur a $100,000 gain subject to tax.
Estate Planning Benefits with 1031 Exchanges
While 1031 exchanges defer tax liability, they don’t eliminate it unless the property is inherited. Tax liabilities expire upon death, so heirs won’t owe deferred taxes on inherited property obtained through a 1031 exchange, as it is reset to the market rate value at inheritance.
1031 Exchange Eligibility for Principal Residences
Primary residences generally don’t qualify for 1031 exchanges because they aren’t held for investment. However, if you convert your primary residence into a rental, it may be eligible.
1031 Exchange Process Support
The process can be complex, involving numerous documents, legal guidance, and a qualified intermediary to manage funds and ensure tax compliance.
Identification Rules for
Replacement Properties
3-Property Rule
You may identify up to
three properties, regardless
of their value.
Exceptions
If you acquire 95% of the
identified properties’ combined
fair market value, the exchange
will be considered valid.
200% Rule
If identifying more than three
properties, their total value
must not exceed 200% of the
sold property’s value.
Same Taxpayer Requirement
Any taxpayer or tax entity can complete an
exchange, but the replacement property’s
title must be held in the same way as the
title on the relinquished property.
Suitability of Oil, Gas, and
Mineral Rights for Investors
1 Ideal Investor Profile for Oil,Gas, and Mineral Rights
Mineral rights, also known as “mailbox money,” provide passive monthly income from operators to investors. This makes them suitable for investors seeking a low-management, passive income property since royalty owners have no involvement in operational responsibilities or expenses.
2 Advantages over
Traditional Real Estate
Mineral royalty rights are rare to acquire, and therefore less influenced by large-scale Wall Street investment. Unlike standard real estate, royalty ownership yields often double typical triple-net property returns and provides a non-correlated asset to traditional markets like stocks and bonds, enhancing portfolio diversity and hedging against inflation. Additionally, royalty owners benefit from a tax shield of 15% of gross income through a depletion allowance.
3 Owner Involvement in
Royalty Management
Royalty ownership is highly “hands-off,” as royalty owners have no role in day-to-day well operations, costs, or liabilities. Once established with an operator, monthly income is provided, along with a 1099 form each January.
4 1031 Exchange Process for
Acquiring Mineral Rights
Identifying royalty property in a 1031 exchange can be more complex than standard property addresses, as the IRS requires detailed listings of wells on the property. However, Wheeler Ridge manages this identification process, making the transaction straightforward, with closings often completed within weeks.
5 Risks Involved in
Royalty Investments
Two primary risks in royalty ownership are production and pricing. Production risk is mitigated through engineering analysis that forecasts reserves over 30 years. However, commodity prices for oil and gas remain unpredictable, causing income fluctuations. Given recent lows in these prices, downside risk may currently be limited.
Get Started Today
If you’re interested in facilitating a 1031 exchange or receiving preliminary information, Wheeler Ridge is interested in speaking with you. Contact us today to learn more about how our company can help you get the most value from the sale of your relinquished property.
Wheeler Ridge’s team of industry experts help Mineral Royalty and Producing Working Interest owners sell their assets at the absolute best value..