Understanding 1031 Exchanges

One of the tax advantages that mineral rights owners may be able to take advantage of as a result of the sale of their mineral rights is called a 1031 Like-Kind Exchange. By using a 1031 Exchange, you can actually qualify to pay no taxes at all on the proceeds of your sale.

Here’s how it works. Bear in mindwe are not accountants and are not qualified to give accounting advice. Sales of mineral rights are classified as a sale of real estate. If you make a profit from the sale of real estate, that profit is normally subject to capital gains taxes.

However, Section 1031 of the Internal Revenue Code allows proceeds from the sale of real estate to be applied towards the purchase of another piece of “like kind” real estate, thus deferring capital gains taxes on the profit. For example, you might use the proceeds from selling your mineral rights to purchase a vacation home or a farm.

Although the basic concept of a 1031 Exchange is fairly easy to understand, we’re talking about tax law here, so naturally it’s not simple. There are rules and guidelines around what it means for two properties to be “like kind” and time limits apply to how long you must have owned the property and how long you have after the sale to reinvest the proceeds.

In addition to being able to defer capital gains taxes, you may also be able to take advantage of a depletion allowance to reduce your mineral rights and royalty taxes. Since minerals are a finite source, you can generally deduct up to 15% of the income from your mineral rights to account for the reduction of reserves over time. If you own this type interest and are not taking depletion off your tax return, you might be shortchanging yourself.

If you’re interested in taking advantage of the incredible tax savings that sellers of mineral rights may qualify for, consult your accountant or tax advisor.