The Tax Deferring Advantages of 1031 Exchanges for Mineral Rights
One way to defer capital gains tax on the sale of royalty or mineral interests is through a 1031 exchange. “1031” refers to the section in the IRS code that allows mineral owners to defer capital gains taxes on the sale of their mineral or royalty rights when exchanged for another qualifying property.
What Properties Qualify for 1031 Exchanges?
When considering selling mineral interests and deferring taxes through a 1031 exchange, keep in mind that the IRS recognizes only certain properties for an exchange. The property must be a “like-kind” property. This basically means that the proceeds from the sale of mineral rights can only be used to purchase other property of the same nature or character. This can include real estate or other mineral rights held for investment.
Keep in mind that to maximize your benefit, the property purchased must be of equal or greater value than the property sold. If the property sold is less than the property purchased you must pay capital gains tax on the difference.
45/180 Day Rule
The IRS is very strict when it comes to the timing between selling your mineral interests and buying another investment or piece of real estate. The IRS allows 45 days after the sale of your mineral interest for you to identify another investment. Then, the IRS allows 180 days between the sale of your mineral interest and the closing of the new investment. With this in mind, it is important to have a very good feel for what property you will be exchanging for your mineral interest in order to keep in compliance with the 1031 exchange rules.
How To Initiate a 1031 Exchange
1031 exchanges can be a complicated task involving a plethora of documents, lawyers, and confusing legal jargon. Mineral owners often rely on a Qualified Intermediary to help streamline the 1031 exchange process. Qualified intermediaries are responsible for preparing all the documents for the 1031 exchange and ensuring that the funds are safely and properly exchanged. They also act as advisors during the process to ensure that you receive all of the tax benefits possible from the 1031 exchange.
Tax Benefits of the 1031 Exchange
From 2005 to 2007 alone, $200 billion of property changed hands through the use of 1031 exchanges. The popularity of the 1031 exchange is testament to its substantial tax benefits. These tax benefits include:
- Postpones the taxes due on qualifying properties
- Allows investors to diversify their portfolios without getting hit with capital gains taxes
- Maximizes the amount of capital available to invest in other real estate, mineral interests, etc.