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In the energy industry, there are typically three investment opportunities
into domestic reserves, but only two that qualify for a 1031 Exchange.
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The first investment option into energy is to invest in a Drilling Program.
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Investing in a drilling program is recommended by some investment professionals for sheltering income or Capital Gains by using intangible drilling cost deductions, but you can't qualify a 1031 Exchange into a drilling program. Just as you can't do a 1031 Exchange into a property that is being built, you can't do a 1031 Exchange into a well that has not yet been placed into service.
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The second investment option into energy, which does qualify for a 1031 Exchange, is Working Interests in producing wells.
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Working Interests are participating (lessee) interests in land, and are expressed as a fraction or a percentage. Working Interest owners lease the rights to drill and produce, while assuming 100% of the risk associated with all operations, and retain what is left, only after paying the Royalty Interest owner. Working Interest owners are subject to monthly cash calls and invoices as well as economic, environmental and operational risk.
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The third investment option into energy, which also qualifies for a 1031 Exchange, is Energy Royalty
Interest Rights (aka Royalties).
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These investments do qualify for a 1031 Exchange, provided the owner is on the title as a direct assignment. In the energy industry, owners of energy rights have been doing 1031 Exchanges from well to well for decades. This is not something new.
A Energy Royalty Right owner does not own the lands' Surface Rights and they have nothing to do with operating the drilling activity. Instead, people in the drilling industry have to pay the Royalty owners rent called Royalties for the right to punch a hole through their land - whether they find energy or not. This is not much different than if you leased your land to a builder who paid you rent for the use of your dirt. Only in the energy industry the Royalty rent is a percentage of the well's gross income for as long as the well is operating - and the Royalty ownership rights are forever. |
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It is easy to
see each of the three investments has their advantages and
disadvantages, but without a doubt, the easiest asset to own of the
three (because it as no expenses or liabilities) are Energy
Royalties. |
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