Investing in Oil & Gas with a 1031 Exchange

It is common for taxpayers to be confused when trying to understand the definition of “like-kind” per Section 1031. Many think that if they sell a single-family rental property, that they can only purchase another single-family rental property.

The like-kind definition under IRC Section 1031 is relatively broad, stating that properties must be held for business or investment purposes but do not need to be of the same grade or quality. For example, that single-family rental can be exchanged for multi-family property, farmland or even a hotel.

Investors may not be aware that specific oil and gas assets also meet like-kind requirements.

Working Interest 

A working interest in oil and gas means an investor’s ownership in a mineral lease and producing well. The tax code deems the lease and well as “real property,” allowing investment property owners to exchange investment property for an interest in oil and gas property. With a working interest, the investor is due a percentage of profits generated from the production but is also responsible for his share of the operating costs.

Royalty Interest

An investor who owns a mineral royalty interest in an oil and gas investment can receive a designated percentage of the potential profits generated from production. However, unlike a working interest, a mineral interest owner is not responsible for any costs associated with production. Mineral royalty interests are also considered real property under the tax code.

Delaware Statutory Trust (DST)

A more recent option for 1031 exchangers interested in oil and gas ownership is the DST. A DST is an investment structure that meets 1031 exchange like-kind property requirements and enables investors to own fractional interests in a portfolio of properties. In the case of an oil and gas DST, the underlying “properties'' are often a pool of mineral royalty interests or other types of real property held for investment purposes.

Please consult with your tax advisor to be assured that you are in compliance with the requirements for your specific transaction.