Oil, Gas, and Other Rights as a 1031 Exchange

successful 1031 Exchange requires that property be exchanged. Contractual rights and obligations pertaining to real property may or may not be characterized as a property interest and, consequently, may or may not be eligible for an exchange.

A working interest is considered a real property interest whereas a royalty interest is not. What is the difference? It is the Exchangor’s rights and obligations to access the property. A working interest is the exclusive right to enter land and extract oil, gas and minerals. It involves the right and cost obligation to explore, drill and develop the oil, gas and minerals. It also carries the obligation of paying for operating expenses. In contrast, a royalty interest allows for a percentage share of production only. There is not any obligation for development or operating expenses. As such, this interest is not considered a real property interest, but rather payment for services.

Clearly, a working interest in gas, oil and minerals may be exchanged to a different working interest in gas, oil and minerals, but what about other type of exchanges? Just as real estate properties can be exchanged as “like-kind” even though the properties are not exactly the same (for example an apartment complex for a vacant lot), the same may be true for property rights, such as the rights to oil, gas and minerals. So, depending upon the particulars of the property, a working interest in oil may be exchanged for a rental house. In contrast, a royalty interest cannot be exchanged for a working interest.

Water rights (the right to access and receive water) and timber rights (the right to enter land and cut down timber) are generally characterized in the same manner as oil, gas and mineral rights. It should be noted, however, that these rights are characterized according to state law. For example, the State of Oregon characterizes that the right to cut standing timber is personal property whereas the State of Georgia characterizes it as real property.