1031 Exchange Mineral Rights: When Royalties Qualify

Key takeaways

• Section 1031 covers only real property. Mineral rights and royalties can qualify when state law treats them as real property, under a Treasury rule finalized in 2020.
• Oil and gas still in the ground can be real property. Once it is pumped out and sold, it isn't.
• Interest type matters. Mineral interests and lasting royalties are the strongest fit. Overriding royalties, net profits interests and production payments need a closer look.
• The usual deadlines apply: identify replacement property in writing within 45 days, and close within 180 days or your tax return due date (with extensions) for the year of the sale, whichever comes first.
• Watch recapture. Part of your gain can be taxed as ordinary income if you deducted drilling costs or took depletion, even inside an exchange.
• Mineral and royalty programs are illiquid securities. Distributions are not guaranteed, and you can lose your entire investment.

Can you 1031 exchange mineral rights?

You can exchange mineral rights in a 1031 exchange when they count as real property under the law of the state where they sit and the other 1031 rules are met. Whether your interest passes that test depends on its type, how long it lasts and that state's law, so "it depends" is the honest answer. Let me start with the basics and add the details one at a time.

A 1031 exchange is a tax rule. It lets you sell investment real estate and buy other investment real estate without paying capital gains tax right away. The tax is deferred, not erased. If you later sell for cash, the old gain comes due. My guide to 1031 exchange rules covers the full set of requirements.

Mineral rights are ownership of the oil, gas and other minerals under a piece of land. They can be owned together with the surface, or split off and sold on their own. When they are split off, people call them "severed" minerals.

A royalty is a share of the money from oil and gas produced from a property. The royalty owner doesn't pay to drill or run the wells. If you want the full picture of how royalty checks are figured, I wrote a plain-English explainer on what oil and gas royalties are.

The core statute is short. Section 1031(a)(1) says "No gain or loss shall be recognized on the exchange of real property held for productive use" in a business or for investment, when it is exchanged for real property of like kind. Since 2018, only real property qualifies.

So the whole question comes down to one test. Is your mineral or royalty interest real property? If it is, it can be traded for a rental house, raw land, a warehouse or another mineral interest. If it isn't, the exchange fails, and you owe tax as if you sold.

There are two directions people go:

1. Out of minerals. You sell mineral rights or royalties and buy real estate, such as an apartment building or an interest in a Delaware statutory trust.
2. Into minerals. You sell real estate and buy mineral or royalty interests, either directly or through a program built for exchange investors.

Both directions use the same rules. The details that trip people up are different, so I cover each one below.

What counts as real property in a mineral rights exchange?

In 2020, the Treasury Department finalized a regulation that defines "real property" for Section 1031. It lives at 26 CFR 1.1031(a)-3. Three parts of it matter for minerals.

Rule 1: Natural deposits in the ground

The regulation lists what counts as real property. It includes "Unsevered natural products of land, including growing crops, plants, and timber; mines; wells; and other natural deposits."

"Unsevered" means still attached to the land. Oil in the rock is unsevered. The same paragraph says these items stop being real property "when they are severed, extracted, or removed from the land."

Here is the practical meaning. Your interest in oil and gas still in the ground can be real property. A barrel of oil in a storage tank is personal property. A check for last month's production is cash.

Rule 2: The state-law test

The regulation adds a second path. Property can be real property if "the property is real property under the law of the State or local jurisdiction in which that property is located." The test is applied on the date the property is transferred.

Notice the words "in which that property is located." What matters is the law of the state where the minerals sit, not the state where you live. If you live in California and own royalties in Oklahoma, Oklahoma's property law is the one your CPA and attorney check.

State property law varies. The answer can turn on the type of interest, how it was created and how long it lasts. That is why a written opinion from an attorney who knows the state matters so much.

Rule 3: What the preamble changed

When Treasury finalized the rule, it published an explanation called a preamble. It is in Treasury Decision 9935.

The preamble notes that the proposed rules would have left out certain intangible assets "such as mineral extraction rights or timber cutting rights." The final rules dropped that limit. The preamble says that under the final regulations, "the mineral rights and timber cutting rights are real property" if they are real property under state or local law.

This was the single most important change for mineral owners. Before the final rule, some tax professionals worried that mineral rights could fall outside the new definition. The final rule settled that question in favor of state law.

What the regulation leaves out

The same regulation lists things that never count, no matter what state law says. It excludes stock (other than certain cooperative housing stock), bonds and notes. It also excludes most partnership interests.

That last point matters a great deal for oil and gas, where joint ventures are common. I cover it in the section on partnerships below.

The regulation also lists intangible interests that are real property. They include "Fee ownership; co-ownership; a leasehold; an option to acquire real property; an easement." Many states treat an oil and gas lease as an interest in real property, though states label it differently. That is one reason lease-based interests can sometimes qualify too.

Which oil and gas interests can qualify for a 1031 exchange?

People use the words mineral, royalty and working interest as if they mean the same thing. They don't. Each one carries different rights, costs and 1031 questions.

"Needs a closer look" doesn't mean "fails." It means the answer turns on state law, the documents and how long the interest is likely to last. Let me take each one in turn.

Mineral interests

A mineral interest is ownership of the minerals in place. The owner can usually sign leases, collect a signing bonus and keep a royalty. It doesn't end when a lease ends.

Because it is ownership of something in the ground, a mineral interest is the closest thing to "land" in the oil and gas world. When the state where it sits treats it as real property, it is usually the cleanest fit for a 1031 exchange.

Royalty interests

A royalty interest is a right to a share of production revenue, free of drilling and operating costs. A royalty usually comes from mineral ownership. When a mineral owner leases to an oil company, the owner keeps a royalty.

Some royalties are non-participating. The owner gets paid but can't sign leases or receive bonus payments.

A perpetual royalty lasts until it is sold. A term royalty lasts only for a set number of years, or for as long as production continues. Duration matters for a 1031, and I give it its own section below.

Overriding royalty interests

An overriding royalty interest, or ORRI, is a royalty carved out of the working interest, not out of the minerals. It is cost-free like a regular royalty. But it is tied to one lease. When that lease ends, the override usually ends too.

That limited life is what makes tax professionals careful. An override on a lease with decades of production ahead looks very different from one on a lease likely to end soon. Your attorney will look at the state's treatment and the lease terms.

Net profits interests

A net profits interest, or NPI, pays a share of the profit from a lease, after costs. The owner doesn't write checks for drilling. But costs come out before the NPI owner is paid, so the share can shrink to zero in a bad year.

The IRS's oil and gas audit handbook, in the Internal Revenue Manual, part 4.41.1, says "A net profits interest is considered to be an overriding royalty payable out of the working interest income." So it raises many of the same questions an override does, plus questions about how costs are measured.

Production payments

A production payment is a right to a set amount of production, or a set amount of money from production, that ends once it is paid out. The IRS manual describes it as "a share of the minerals produced from a lease, free of the cost of production."

The tax code treats most production payments like loans. Under Section 636(a), a carved-out production payment "shall be treated, for purposes of this subtitle, as if it were a mortgage loan on the property." Under Section 636(b), one kept by the seller in a sale is treated "as if it were a purchase money mortgage loan."

A loan isn't real property. So if you are offered a production payment as replacement property, or you plan to keep one when you sell, talk with your CPA first. In most cases it won't work the way an exchange needs it to.

Working interests

A working interest is the right to drill and produce, with the duty to pay a share of the costs. Working interest owners can get bills for new wells and repairs. Royalty owners don't.

A working interest is usually held under an oil and gas lease. In a state that treats that lease as real property, a working interest can qualify. But how it is held matters, and so do the equipment, the drilling-cost recapture rules and the liability. I compare the two sides in depth in my guide to working interest vs. royalty interest.

Interests held through partnerships

Many oil and gas interests are held through a joint venture. For tax purposes, a joint venture is often a partnership: a business owned by two or more people that passes its income to its owners.

A partnership interest is not real property under the 1031 rules. But there is a special rule for some oil and gas co-owners. Section 1031(e) treats an interest in a partnership that has "in effect a valid election under section 761(a)" as an interest in each of the partnership's assets.

That election comes from Treasury Regulation 1.761-2. It can be used by a group formed "for the joint production, extraction, or use of property," but "not for the purpose of selling services or property produced or extracted." The owners must hold the property as co-owners and each keep the right to "take in kind or dispose of their shares" of production.

If you hold oil and gas through a joint venture, ask your CPA whether that election is in place. It can be the difference between owning a real property interest and owning a partnership interest. My guide to 1031 exchanges for partnerships, trusts and LLCs covers the broader rules for entity owners.

Does it matter whether a royalty is perpetual or for a set term?

Yes. Duration is one of the most common questions with royalty exchanges.

Think about why. A mineral interest or perpetual royalty looks a lot like owning land. It goes on until someone sells it. A term royalty for 10 years looks more like a stream of payments with an end date. The shorter and more certain the end date, the less it looks like real property.

The older like-kind regulation gives a useful reference point. Treasury Regulation 1.1031(a)-1(c) says no gain is recognized if a taxpayer "exchanges a leasehold of a fee with 30 years or more to run for real estate." That rule speaks to leases of land. It doesn't speak directly to royalties. But tax professionals often use it when they think about interests that end.

Here is how I'd frame the questions to bring to your attorney:

• Does the interest end at a fixed date, or when production stops?
• How long is production likely to last, based on the reserve report?
• How does the state where the minerals sit classify this kind of interest?
• Is the interest really a production payment, which the code treats as a loan?

A short-lived interest can still have real value. It just may not count as real property for an exchange.

What official guidance and rulings apply to mineral rights exchanges?

People often ask which IRS rulings "prove" their royalty qualifies. Here is an honest map of what exists and how much weight each piece carries.

The statute and regulations

These carry the most weight. Section 1031 sets the rule. Regulation 1.1031(a)-3 defines real property and includes natural deposits and the state-law test. Regulation 1.1031(a)-1 explains that like-kind refers to "the nature or character of the property and not to its grade or quality."

That last phrase is why a royalty can be like-kind to an apartment building. Both are real property. The fact that one produces oil and the other produces rent relates to grade or quality, not kind or class.

The 2020 preamble

The preamble in Treasury Decision 9935 explains how Treasury reads its own rule. Its statement that mineral rights are real property if state law says so is the clearest official word on the subject.

The same preamble also notes that "oil and gas firms accounted for approximately $4 billion in deferred gains in 2012."

Revenue Ruling 2004-86

Revenue Ruling 2004-86 is the IRS ruling behind Delaware statutory trusts. It concludes that "A taxpayer may exchange real property for an interest in the Delaware statutory trust" without recognizing gain, if the other 1031 requirements are met.

That ruling involves a building, not minerals. But some programs hold royalty interests in a Delaware statutory trust, and they rely on this ruling's structure.

Older rulings and court cases

Before the 2018 change, many revenue rulings and court cases dealt with oil and gas exchanges. Your tax attorney may cite some of them. They can still be useful, but they were decided under older law and older regulations. Ask your attorney how each one fits under the current definition of real property.

Private letter rulings

A private letter ruling is an answer the IRS gives one taxpayer about that taxpayer's own facts. You may see them quoted online.

Be careful. Under Section 6110(k)(3), "a written determination may not be used or cited as precedent." In plain words, someone else's ruling can show how the IRS has reasoned, but it doesn't protect you.

Putting it together

How does a 1031 exchange out of mineral rights work, step by step?

Say you own minerals or royalties and want to sell them and buy real estate. Here is the general process. Your qualified intermediary and CPA set the details.

Step 1: Confirm the interest is held for investment

Section 1031 covers property held for investment or for use in a business. It doesn't cover property "held primarily for sale." Minerals you inherited and have collected royalties on for years usually look like an investment. Interests you buy and flip often look like inventory.

Step 2: Get a state-law answer before you list

Ask a title attorney in the state where the minerals sit how that state classifies your interest. Get it in writing. If your interests sit in three states, you may need three answers.

Step 3: Hire your intermediary before closing

A qualified intermediary, or QI, is the independent company that holds your sale money during an exchange so you never touch it. It must be in place, with a written exchange agreement, before your sale closes. My guide to the qualified intermediary role explains what to look for.

Mineral sales often run through auctions, brokers or direct offers from buyers. Tell the buyer early that you are doing an exchange. The deed and closing statement need to send the money to your QI, not to you.

Step 4: Handle effective-date money carefully

Mineral sales usually set an effective date. Production after that date belongs to the buyer. Because royalty checks lag production by months, you may receive checks for the buyer's months after closing, or the buyer may get checks for yours.

These adjustments change the sale price. Cash that reaches you instead of your QI can be taxable. Ask your QI and CPA in advance how post-closing checks and price adjustments will be handled.

Step 5: Identify replacement property within 45 days

Your 45-day clock starts the day the sale closes. You must identify replacement property in writing, signed by you, and delivered to your QI. Under Treasury Regulation 1.1031(k)-1, you can generally name up to three properties of any value, or more if their total value stays within 200% of what you sold.

A backup property only helps if it was identified in writing within the 45 days. My guide to the 1031 exchange identification rules covers the options in depth.

Step 6: Close within the exchange period

You must receive your replacement property within 180 days or your tax return due date (with extensions) for the year of the sale, whichever comes first. A sale late in the year can run into the tax return due date, so plan for an extension if you need it. My 1031 exchange deadline calculator can help you map the dates.

Step 7: Report the exchange

At tax time, your CPA reports the exchange on IRS Form 8824. The IRS describes the form as the place to "report each exchange of business or investment property for property of a like kind."

How does a 1031 exchange into mineral rights work?

The other direction starts with real estate. You sell a rental or a commercial building and use the money to buy minerals or royalties.

Buying interests directly

You can buy royalty or mineral interests from individual owners or brokers. It can work, but it is hard inside 45 days. You need title work in each county, a review of the deeds and leases, a reserve estimate and a fair price. Many direct buyers start their research months before they sell.

Buying through a program

Some sponsors build royalty programs for exchange investors. A sponsor is the company that puts the investment together and manages it. These programs usually hold many interests across several basins, with wells run by third-party operators.

Some hold the interests in a Delaware statutory trust, or DST. A DST is a trust that can hold title to real property for many investors. A DST interest can qualify as replacement property under Revenue Ruling 2004-86, if the other 1031 rules are met. Others use different structures. In every case, ask for the sponsor's legal analysis of 1031 eligibility and have your own attorney read it. My guide to DST property types shows where royalty programs fit among other DST sectors.

These programs are securities. Most are private placements for accredited investors only. Under the SEC's rules, described in Investor.gov's accredited investor bulletin, an individual generally qualifies with earned income above $200,000 ($300,000 with a spouse or spousal equivalent) in each of the past two years and a reasonable expectation of the same this year. Net worth above $1 million, not counting a primary home, also qualifies. So does a Series 7, 65 or 82 license held in good standing.

Replacing debt and value

To defer all of your gain, you generally need to buy replacement property worth at least as much as what you sold, and reinvest all your cash. If you paid off a loan at the sale, you need to replace that debt with new debt or extra cash.

Some royalty programs use little or no debt. That can make it harder to replace a loan from your old property with royalties alone. Some investors pair a royalty program with a leveraged real estate investment to balance the numbers.

Comparing the two directions

How do you value mineral rights for a 1031 exchange?

Value matters in an exchange for three reasons. You need to know your gain. You need to buy replacement property of equal or greater value to defer all of it. And your CPA reports fair market values on Form 8824.

Mineral rights are harder to value than a house. There are no comparable sales on every street. Here are the main pieces an appraiser or buyer looks at.

Producing wells

Proved developed producing reserves, often shortened to PDP, are the oil and gas expected from wells already producing. A reserve report from a petroleum engineer estimates how much those wells will produce over time. That estimate, times assumed prices, minus taxes and deductions, gives a stream of future income. The appraiser then discounts that stream to today's value.

Future drilling

Acreage where wells haven't been drilled yet can have value too. That value depends on whether an operator is likely to drill, and when. It is more uncertain than income from wells already producing.

Price assumptions

Small changes in assumed oil and gas prices can move the value a lot. Ask what prices the valuation assumes and what happens if prices are lower.

Decline

Wells produce less over time. A decline curve is a chart of that drop. A valuation that assumes a slower decline than the wells really show will be too high.

The lease terms

Royalty rate, post-production deductions and lease expirations all change what an interest is worth. Two royalties with the same acreage can be worth very different amounts.

For your exchange, the practical advice is simple. Get a written valuation or reserve report from an independent source when you sell or buy directly. Keep it with your tax records. If you buy through a program, read how the sponsor set its purchase price and who prepared the reserve report.

A worked example: selling inherited royalties and buying real estate

This is a hypothetical example with round numbers. It doesn't represent any offering, any client or a typical result. It isn't tax advice, and your CPA should run your real figures.

The starting point

Say your aunt left you royalty interests in Texas. Under Section 1014, your basis became "the fair market value of the property at the date of the decedent's death." Assume that value was $400,000.

You held the royalties for investment for several years. You took $50,000 of cost depletion, so your adjusted basis is now $350,000. Depletion is a tax deduction that reflects the oil and gas used up as it is produced.

A buyer offers $900,000. Selling costs are $20,000.

What a taxable sale would look like

Your gain is $900,000 − $20,000 − $350,000 = $530,000.

Of that gain, $50,000 matches the depletion that reduced your basis. Under Section 1254, that part can be taxed as ordinary income. The remaining $480,000 would generally be long-term capital gain. Federal tax on that, plus the 3.8% net investment income tax (a federal tax on investment income above certain income levels) and any state tax, can add up to a large bill. To see a rough version for your own numbers, try my 1031 tax deferral calculator.

The exchange

Instead, your QI holds the $880,000 of net proceeds. You identify a rental building within 45 days and buy it for $880,000 within the exchange period. You reinvest all the cash and buy property of equal value. In general, the $480,000 of capital gain is deferred.

The recapture catch

Here is the part people miss. Section 1254 says recaptured gain "shall be recognized notwithstanding any other provision of this subtitle." The regulation at 26 CFR 1.1254-2(d) softens that for like-kind exchanges, but only partly.

It caps the recaptured amount at the gain you recognize plus "The fair market value of property acquired that is not natural resource recapture property." A rental building isn't natural resource recapture property. So the cap here is $0 + $880,000. The full $50,000 of depletion recapture can be taxed as ordinary income, even though you reinvested everything.

If you exchange into other mineral interests, the replacement property may itself be natural resource recapture property. In that case, the recapture may carry over instead of being taxed now. Your CPA has to run the allocation rules in the regulation, so treat this table as an outline, not an answer.

The lesson: if you've taken depletion or deducted drilling costs, ask your CPA about recapture before you choose your replacement property.

How do depletion and basis carry into your new property?

Basis is your tax cost in a property. In an exchange, your basis generally carries over from the old property to the new one. Nothing resets.

That has two effects for mineral owners.

When you exchange into minerals

Royalty owners can take depletion each year. Section 611 allows "a reasonable allowance for depletion" for oil and gas wells and other natural deposits. There are two methods.

Cost depletion recovers your basis as the reserves are produced. If you exchange a long-held building with a low basis into royalties, your carried-over basis is low too. That limits your cost depletion.

Percentage depletion deducts a set share of gross income. Under Section 613A, the rate is 15% for qualifying independent producers and royalty owners. It applies to up to 1,000 barrels of average daily oil production (or the gas equivalent), a limit that can be reduced in some cases. The deduction can't exceed 65% of taxable income figured before certain items.

An IRS fact sheet from 2013, Tips on Reporting Natural Resource Income, says an owner "must use the method that yields the greater deduction." That page is marked as historical content, so confirm current rules with your CPA.

When you exchange out of minerals

Your depletion history goes with you. It affects the recapture rules above, and your carried-over basis becomes the starting basis for depreciation on your new building. Your CPA splits that basis between land, which isn't depreciated, and the building.

Inherited minerals

If you inherited minerals, your basis is usually the value at death under Section 1014. If that was recent, your gain may be small. Sometimes a plain sale costs little tax, and an exchange adds work without much benefit. My step-up in basis guide explains how inherited basis works. Run both versions with your CPA before you decide.

What if you need to buy before you sell?

A reverse exchange is when you buy the replacement property before you sell the old one. It needs a special holder, called an exchange accommodation titleholder, to own one of the properties until the other side closes.

It can work with mineral rights, and it can help when the replacement is time-sensitive. It costs more and has its own deadlines. My guide to the reverse 1031 exchange explains the structure.

Mistakes to avoid in a mineral rights exchange

1. Assuming every royalty qualifies. Interest type, duration and state law decide it. Get a written answer before you sell.
2. Checking the wrong state's law. The state where the minerals sit controls, not the state where you live.
3. Taking checks after closing. Effective-date checks and price adjustments that reach your bank account can be taxable. Route them as your QI and CPA direct.
4. Ignoring recapture. Depletion and deducted drilling costs can create ordinary income even in a full exchange, especially when you buy a building.
5. Treating a production payment as a royalty. The tax code treats most production payments like loans.
6. Missing the partnership issue. A joint venture interest may be a partnership interest unless a valid Section 761(a) election is in place.
7. Mixing U.S. and foreign property. Section 1031(h) says U.S. and foreign real property are not like-kind. Canadian royalties don't match a Texas rental.
8. Starting research after the sale. Mineral due diligence takes time. Start before you list, not on day 1 of your 45 days.
9. Buying on yield alone. Royalty income moves with prices and production. A high first-year number can fall quickly.
10. Skipping the reserve report. Ask who prepared it, when, and whether the engineer was independent.

What are the risks of exchanging into mineral rights?

Royalties and minerals carry real risks. Here are the ones to weigh before you invest.

• Commodity prices. Oil and gas prices can fall fast and stay low. Royalty income falls with them.
• Production decline. Wells produce less over time. Without new drilling, income from a fixed set of wells tends to shrink.
• Operator decisions. Operators decide whether and when to drill. You don't. An operator in financial trouble can delay payments.
• Concentration. A program tied to one basin, one operator or one product depends heavily on that one thing.
• Title and lease risk. Old deeds and leases can contain errors or terms that reduce your checks.
• Reserve estimates can be wrong. Value depends on engineering estimates that may miss.
• Illiquidity. There is usually no market to sell a program interest early. The SEC warns that private offerings "typically have less liquidity, which means you might have to hold your investment indefinitely" (Investor.gov).
• Loss of your investment. The same SEC alert says, "You should be aware that you could lose your entire investment."
• Distributions are not guaranteed. They can be cut or stopped.
• Tax risk. The IRS could challenge whether an interest is real property. A failed exchange means the deferred tax comes due.
• Fraud risk. The SEC lists red flags, including "Abnormally high rates of return" and "Unsolicited materials." Check anyone selling you an investment on FINRA BrokerCheck.

How I review mineral and royalty programs

My background is in real estate acquisitions, management and development, and I founded Baker 1031 Investments. Royalty programs get the same review as every offering, across five areas: broker-dealer review, investment manager audit, investment offering review, real estate assessment and institutional underwriting. The review is continuous, not a one-time check.

For any royalty program, these oil and gas questions are worth asking:

• How much projected income comes from wells already producing?
• Which operators run the wells, and how strong are they?
• How much income depends on the top few wells and operators?
• What is the mix of oil, gas and natural gas liquids?
• What prices do the projections assume, and what happens if prices drop?
• Who prepared the reserve report, and how recent is it?
• What does counsel say about 1031 eligibility, and in which states?

When we meet, I'll walk you through the offerings I currently have available. I'll tell you why I'm considering each one, what I like and where I have reservations. Securities are offered through Aurora Securities, Inc., member FINRA/SIPC. Baker 1031 Investments is independent of Aurora.

What my data shows

Here is what my offering records as of October 2026 show, across 76 DST offerings from 38 sponsors. These figures describe the offerings I track. They aren't a forecast or a promise about any offering.

Royalty programs are part of the net lease group

Net lease offerings number 15 (20%), and that group includes energy royalty programs. By comparison, multifamily is 31 (41%) and industrial is 18 (24%). Self-storage (5), retail (4) and medical office (3) round out the list.

Royalty programs hold portfolios, not single wells

The royalty programs on the platform hold mineral and royalty interests. Two examples, described generally:

• One portfolio holds 14 royalty properties with 27 producing wells in Oklahoma's Anadarko Basin and Texas's Permian Basin.
• Another holds about 1,277 net royalty acres with interests in 200+ producing wells, roughly 90% natural gas, in the Permian Basin and the Haynesville Shale.

In both, wells are run by third-party operators. The owner receives a share of production revenue and doesn't pay drilling or operating costs.

The mix of products matters for an exchange. A portfolio that is mostly natural gas will tend to follow natural gas prices. Spreading across basins doesn't remove commodity risk.

Debt and minimums

36 of 76 offerings (47%) are all-cash, with no debt. That matters if you need to replace a loan from your old property. An all-cash offering won't help you replace debt.

The median minimum investment is $100,000. Minimums range from $25,000 to $500,000, and 21 offerings (28%) start at $25,000. Lower minimums can make it easier to place a slice of an exchange into royalties next to other real estate.

Not every offering passes review

Of the 76 offerings, 16 are open, 6 have limited availability, 24 are under review, 25 are closed and 5 are offerings that I reviewed and passed on.

Frequently asked questions

Can mineral rights be exchanged for a rental property?

They can, when the state where the minerals sit treats them as real property. Like-kind refers to the nature of the property, not its grade or quality, so real property can generally be exchanged for other real property. Confirm the state-law answer with an attorney before you sell.

Are oil and gas royalties like-kind to real estate?

Royalty interests can be like-kind to real estate when state law classifies them as real property. Treasury's 2020 preamble says mineral rights are real property if state or local law treats them that way. Duration and the type of royalty can change the answer.

Does an overriding royalty qualify for a 1031 exchange?

It might, but it needs a closer look. An overriding royalty usually ends when its lease ends, so its expected life and the state's classification both matter. Ask your attorney for a written analysis.

Can I use a 1031 exchange when I sell inherited mineral rights?

It can, if you held them for investment and the other rules are met. Inherited minerals usually get a basis equal to their value at death, so your gain may be smaller than you expect. Compare a plain sale and an exchange with your CPA.

Do the 45-day and 180-day deadlines work differently for royalty owners?

No. You identify replacement property in writing within 45 days and close within 180 days or your tax return due date (with extensions) for the year of the sale, whichever comes first. Royalty owners just need to start their research earlier, because mineral due diligence takes longer.

Is a production payment real property for a 1031 exchange?

Usually not. Section 636 treats most production payments as if they were loans for tax purposes. Talk with your CPA before you buy or keep one as part of an exchange.

What happens to my depletion when I exchange royalties?

Your basis, already reduced by any depletion, carries into the new property. Past depletion can also trigger ordinary income under Section 1254, even in a full exchange, if you buy property that isn't natural resource recapture property. Your CPA should run this before you pick replacement property.

Can I exchange a working interest into royalties?

It can work, depending on state law and how the working interest is held. Equipment, partnership structure and recapture of drilling costs all need review. My separate guide compares the two interest types in depth.

Can I 1031 exchange mineral rights in Canada for land in the U.S.?

No. Section 1031(h) says real property in the United States and real property outside the United States are not like-kind. U.S. minerals must be exchanged for U.S. real property.

How risky are royalty programs for 1031 investors?

No investment is free of risk, and royalty programs carry commodity, production and operator risk. Distributions are not guaranteed, the programs are illiquid, and you can lose your entire investment. Read the private placement memorandum and the reserve report with your CPA and attorney.

Who should hold my sale money in a mineral rights exchange?

A qualified intermediary, or QI, must hold it, and the QI must be in place before closing, like any delayed exchange. It helps to choose one familiar with mineral sales, effective dates and post-closing revenue checks. Make sure the deed and closing statement send the money to the QI.

Before you act

This guide is for education only. It isn't tax, legal or investment advice, and Baker 1031 Investments doesn't provide tax, legal or accounting services. Please confirm every decision with your CPA, attorney and qualified intermediary. Interests in royalty programs and DSTs are offered only by private placement memorandum to qualified investors, and you can lose your entire investment.

Sources

• 26 U.S.C. § 1031, Exchange of real property held for productive use or investment (Cornell LII)
• 26 CFR § 1.1031(a)-3, Definition of real property (Cornell LII)
• 26 CFR § 1.1031(a)-1, Property held for productive use in trade or business or for investment (Cornell LII)
• 26 CFR § 1.1031(k)-1, Treatment of deferred exchanges (Cornell LII)
• IRS, Treasury Decision 9935, Statutory Limitations on Like-Kind Exchanges
• IRS Revenue Ruling 2004-86
• IRS, Internal Revenue Manual 4.41.1, Oil and Gas Handbook
• 26 U.S.C. § 636, Income tax treatment of mineral production payments (Cornell LII)
• 26 CFR § 1.761-2, Exclusion of certain unincorporated organizations from subchapter K (Cornell LII)
• 26 U.S.C. § 6110, Public inspection of written determinations (Cornell LII)
• 26 U.S.C. § 1014, Basis of property acquired from a decedent (Cornell LII)
• 26 U.S.C. § 1254, Gain from disposition of interest in oil, gas, geothermal, or other mineral properties (Cornell LII)
• 26 CFR § 1.1254-2, Exceptions and limitations (Cornell LII)
• 26 U.S.C. § 611, Allowance of deduction for depletion (Cornell LII)
• 26 U.S.C. § 613A, Limitations on percentage depletion in case of oil and gas wells (Cornell LII)
• IRS, Tips on Reporting Natural Resource Income (FS-2013-6)
• IRS, About Form 8824, Like-Kind Exchanges
• Investor.gov, Updated Investor Bulletin: Accredited Investors
• Investor.gov, Investor Alert: Private Oil and Gas Offerings
• FINRA BrokerCheck