Selling Your Mineral Royalties? You May Be Able to Defer Taxes with a Like-Kind Exchange

Taxes are an inevitable part of life. If you make or receive money for almost any reason, there’s a good chance a slice of that money will get taxed. That’s true of the money you make at your job, and it’s also true of any money you make from oil and gas royalties. 

If you lease your land for oil and gas production, your signing bonus will be taxed as regular income. Any royalty checks you receive after that will also be taxed as regular income at the highest rate—and that’s on top of the income taxes you’re already paying if you’re still working.

While there’s no way to avoid paying taxes on money you make from your minerals, there may be ways to help soften the blow. If you sell your royalties, you might qualify for the lower capital gains tax rate and save money on your taxes. A 1031 like-kind exchange can potentially help you save even more.

 

What is a 1031 like-kind exchange?

“1031” refers to section 1031 of the IRS code, which lays out the rules for certain property exchanges that allow individuals to defer payment of taxes. “Like kind” means you must exchange your investment in one piece of real estate for investment in another piece of real estate (they have to be “like kind” in that they are both real estate, but they don’t have to be exactly alike). 

For example, through this piece of tax code, an individual could sell a piece of property like an apartment complex for a profit and use the money from the sale to invest in a larger apartment complex without paying taxes on the gains from the first sale. This type of exchange is commonly used by real estate investors.

For an in-depth look at how 1031 exchanges work, check out this post. 

 

How do like-kind exchanges apply to oil and gas royalties? 

Your minerals are considered part of your “property”. Through section 1031, the IRS allows you to take money obtained from the sale of property (which includes the sale of oil and gas royalties) and use it to reinvest in “like-kind replacement properties.” So, in a like-kind exchange, the taxes that would normally be paid on a royalty sale are deferred as long as you reinvest the money in another property. 

If you’re already planning to use the money from selling your royalty to purchase property, this could save you a lot of money on your tax bill. However, there are a couple strings attached:

1. In a like-kind exchange, the property being sold and the property being purchased must both be used for business or investment.

2. The property being purchased must be purchased within 45 days of selling your royalty.

We encourage all of our landowners to talk to a certified public accountant or a tax lawyer before making any decisions or taking any actions. 

 

How one Ohio landowner used a 1031 exchange to defer taxes

At Gateway Royalty, we recently partnered with Nancy Deucker, a Harrison County landowner who wanted to sell a portion of her mineral royalties and do a 1031 like-kind exchange. You can read more about her story here.

Nancy had heard about the idea of a 1031 like-kind exchange and was interested in the idea of putting all the money she received from Gateway Royalty to work as an investment. As Nancy explained it:

“For someone who owns income producing real estate, which includes royalty interest, rolling the money into a 1031 exchange for a new income-producing property is an opportunity to delay paying the federal government income tax on the profit of that exchange so that you can put the entire dollar amount to work for you.”

Thanks to a 1031 like-kind exchange, Nancy was able to take the upfront payment she received for her oil and gas royalties and invest it in another property—without paying taxes on it right now. And you may be able to do the same. 

If you’d like to learn more about selling your royalty or the potential for doing a 1031 like-kind exchange with your mineral royalty sale, call Gateway Royalty today at 330-627-4200.