In a 1031 exchange, the Internal Revenue Service considers a lease of thirty or more years the same as real property. This is significant because lessees are able to sell their interest and replace with any type of real estate of equal or greater value. Fast food franchises, retail, cell tower and bill board lessees benefit from the 1031 exchange allowing them to defer the gain into another property. Lessor’s or landlord’s lease interest is not exchangeable and is treated as the receipt of advance rental income per Pembroke v. C.I.R. (1931) and Crooks v. C.I.R. (1989).
Leasehold Interests
A fee interest in land is like-kind to a lease interest in land given a term of thirty years or more. The lease qualifies if the term has renewable options extending over the thirty year threshold. The initial term could be ten years. If the lessee has five optional renewable five year terms, the thirty-five year periods would satisfy the 30-year requirement. The option to renew must be the lessee’s and not the lessor’s.
A taxpayer’s reversionary interest or the right to take back the property ownership interest upon the death of the lease holder allows the taxpayer to exchange out of the leasehold interest as the tenant and acquire a sublease in the same property qualifying as replacement property. Revenue Ruing 76-301 provides that the taxpayer may transfer its leasehold interest in the entire building and acquire a sublease of a portion of the building as replacement property.
Mineral Leases
A lessee’s interest in a mineral lease of thirty years or more is considered like kind to a real estate interest qualifying, for a 1031 tax deferral. In a mineral lease, the lessee has the right to extract the minerals for a set period of time or until exhaustion. Leasehold interests of less than thirty years is considered a carve out and not eligible for a 1031 exchange. A production payment represents a right to the mineral for a mutually agreed upon price and does not qualify for a 1031 exchange.
A mineral royalty allows the holder to receive a percentage of all minerals produced until exhaustion or in perpetuity. Per Revenue Ruling 73-428 and 72-117, a royalty interest is considered a real property interest for federal tax purposes and is eligible for a 1031 exchange. The Internal Revenue Service determined an overriding oil and gas royalty qualifies for 1031 treatment. An overriding royalty interest is when the mineral lessee grants a sublease while retaining a royalty interest. The lessor ceding the mineral lease maintains a royalty interest and does not qualify for a 1031 exchange.
In Crooks v. C.I.R. (1989), a transfer of mineral rights underlying farm property was exchanged for a 25 percent royalty interest in the oil and gas produced and a fee interest in other land was determined to be not like kind. The Tax Court found that the transaction was a lease because of the taxpayer retained economic interest.
Mineral interests transferred with real estate are not a separate asset to the taxpayer who conveys the property per Butler Consol. Coal Co. v. C.I.R. (1946). In Beeler v. C.I.R. (1997) unmined sand in land containing a sand mine was not separate property and not eligible for a 1031 exchange. In Peabody Natural Resources Co. v. C.I.R. (2006), the Tax Court determined that coal supply contracts are a bundle of rights subordinate to the ownership of the coal mines and not separable from the ownership of the land and the coal mine reserves.
Atlas 1031 Exchange has accommodated 1031 exchanges for cell tower, fast food franchise and mineral interests when the lessor is selling their thirty year leasehold interest. Mineral leases require an understanding of the rights to establish whether they are eligible for a 1031 tax deferred exchange.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
