You may achieve substantial tax savings by implementing a Like-Kind Exchange (LKE) program on various investment properties with help from Petroleum Strategies Inc. Under Internal Revenue Code (IRC) Section 1031, an LKE defers capital gains tax or depreciation recapture on the disposal of obsolete assets and the acquisition of new assets. An LKE can be structured if you first sell an asset (known as a Forward LKE) or buy an asset (a Reverse LKE). To ensure transaction integrity, taxpayers use a Qualified Intermediary (QI). Petroleum Strategies is the nation’s most experienced QI in the energy sector, helping our corporate clients defer millions of dollars in capital gains tax each year.
Yes, and each divestiture needs to be examined to determine if it is a good candidate for 1031 tax treatment. In this economic climate, it is clear that mineral interests are changing hands at a very feverish pace. What is somewhat less clear is that these need not be taxable transactions. In fact, both the sellers and the buyer benefit when capital gains taxes do not have to be subtracted from the sales price. By taking advantage of the 1031 exchange tool, sellers get to keep more wealth, and buyers can consummate more deals more quickly if they are knowledgeable about Section 1031 of the Internal Revenue Code. Section 1031 states that no gain or loss shall be recognized (or taxed) if property held for productive use in a trade or business or held for investment is exchanged solely for property of a like-kind to be held for investments, or for productive use in trade or business.
The definition of like-kind is crucial, in that like-kind does not mean that the seller of a mineral interest has to buy another mineral interest. Many people think a sale of mineral interest must be followed by the purchase of another mineral interest. This is not the case, and the definition of like-kind is much broader, which allows sellers to re-invest in other categories of qualifying properties. For example, all real estate in the United States is considered to be like-kind to any other domestic real estate, as long as each property qualifies for the proper use. The only requirement to meet the qualifying use standard is that the property is held for use in trade or business or for investment. Holding a property for appreciation constitutes “holding for investment. Thus, mineral interests that have been held for investment (not purchased for imminent sale after they were acquired) can be sold as part of a 1031 exchange, and the proceeds can be used to purchase a ranch, multi-family rental property, commercial building, undeveloped land, resort investment property, and so on. The following are examples of valid exchanges:
- Overriding royalty for unimproved real estate
- Mineral interests for an investment resort property
- Interest in a producing oil lease extending until the exhaustion of the deposit for a ranch property
- Perpetual water rights for a fee interest in land
- All the above can be interchanged, and the properties can be in different states.
Interests that may not qualify are those that are limited in duration. When operating interests are exchanged, the well equipment must be analyzed separately from the exchange of leasehold interests. Oil & Gas property owners can divest without paying the capital gains taxes if they properly complete the sale as part of a 1031 exchanges, where Petroleum Strategies can serve as the Qualified Intermediary on this transaction.
The longer the better. Unfortunately, there is no safe holding period for property to automatically qualify for an exchange. Keep in mind, the property only needs to be “held for investment” for it to be eligible for an exchange. Time of ownership is only one factor the IRS looks at when determining if the property was “held for investment”. Some tax advisers recommend a minimum holding period of one year.
Yes, this requires that you do a reverse exchange however. This is a much more challenging and expensive approach to completing a 1031 exchange. It “may” be an option provided that you have the ability to structure the reverse exchange according to the safe harbor guidelines. Typically, the Qualified Intermediary will set up an EAT (exchange accommodation titleholder) that will hold title to this replacement property, until the exchangor is able to sell their relinquished property, and at that time the title will pass back to the exchangor.
No, however any cash that is not re-invested in the exchange will be taxable (and commonly referred to as “cash boot”). The rule of thumb is if you do not want to pay any taxes, you will need to re-invest all of your cash, and purchase a property of equal or greater in value.
180 days to complete it, meaning close on your replacement property purchases. However, keep in mind that you will be required to identify your potential replacement properties on day 45 of your exchange. The time line starts when you close escrow on the property you are selling, and this is considered one of the most challenging aspects to the exchange process.
We are the industry leader in all types of 1031 exchanges, and have pioneered the development and systematization of the LKE process for many new asset categories. We have been focusing on energy like-kind-exchanges for the past 25 years and are your strategic partner on these complex tax deferred exchange transactions. We provide the expertise, personalized service and a commitment to help you meet your strategic tax deferral objectives.
Yes, Petroleum Strategies has facilitated a vast number of exchanges of real estate over the years. Please don’t let our name fool you, we do them all!
Petroleum Strategies, Inc. does not give tax or legal advice. The information contained herein should not be relied upon as a substitute for tax or legal advice obtained from a competent tax and/or legal advisor.