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Using a 1031 Exchange for an Oil & Gas property can be lucrative

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By : Mike Traweek    99 or more times read
This article discusses the well known 1031 Exchange program in relation to the oil and gas industry. Our goal is to show how this specific exchange can be superior to a real estate for real estate exchange. Part of this process requires knowledge of the oil & gas industry, so to accomplish that we have included a link to our Guide to investing in oil & gas.

To emphasize the benefits of this proposed exchange, we need to discuss the benefits available to the investor in an oil & gas program. The two categories of benefits are income and tax benefits. To further clarify, we are focused on oil & gas drilling and production programs, including Royalty Interests.

Income potential in a successful oil & gas program is unequaled as an investment. It is not uncommon for investors to receive 5 or more times their original investment over the life of a project. Of course the key here is success which our Guide discusses in detail. For now let’s focus on income and the next benefit, tax relief.

The tax code was refined in 1986 to encourage further investment in oil & gas drilling programs. These benefits include:

- 100% of the Intangible Drilling Costs (IDC’s) can be written off immediately

- Equipment can be depreciated over 7 years regardless of the life of the equipment

- 15% of your income is tax free (that’s right- tax free, not a write off)

When you combine these two categories you can see why we believe this vehicle is unmatched in what it can provide to the prudent investor. To make this happen, the 1031 Exchange must follow the guidelines of law, and the "Replacement Property” must be carefully selected to maximize the gain. In this case the "Replacement Property” is the oil & gas interests.

Selecting the proper "Replacement Property” takes planning and must not be rushed. Therefore, the investor must bear in mind the time constraints to which one must adhere to qualify for tax deferred status. We recommend completing the research on the "Replacement Property” prior to the closing of the real estate so as to insure the transaction will comply with IRS guidelines, specifically to comply with the 45/180 day rules.

An example might help to illustrate how this can work. An investor has a planned closing of a real estate investment property and recognizes that a 1031 Exchange will be of benefit. After thorough research, this individual then decides to utilize an oil & gas property as the "Replacement Property”. A property is found that fits the requirements to qualify as follows.

A lease of mineral rights of several thousand acres is available. The ownership of these mineral rights should return, according to a geological report, the original investment amount plus approximately 18% for each of the next 3 years in addition to which it will provide a long term monthly income for 10 years. The investor decides to take this route at which time they contact a Qualified Intermediary and proceed with the transaction in the same manner as they would when exchanging real estate for real estate. The end result is the investor defers the tax, earns an additional profit, and earns monthly income over a number of years.
Mike Traweek
Mike Traweek has 30 years of experience in sales and marketing, 20 of which is in the oil & gas industry. His experience includes managing drilling programs in Texas and Kansas as a General Partner. He can introduce investors to a Qualified Intermediary for the exchange if requested.

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