Mineral Rights: Using Oil & Gas Royalties for 1031 Exchanges
While most real estate investors look to apartments or industrial buildings when executing a 1031 exchange, a sophisticated alternative exists beneath the surface: Oil and Gas Mineral Rights.
This guide explores how mineral royalties function as "like-kind" real estate, allowing you to defer capital gains taxes while diversifying into an asset class that offers monthly cash flow without the headaches of traditional property management.
Now that we have the legal green light out of the way, let’s talk about why you are likely here. If you are like most of the property owners I consult with, you have reached a point where "pride of ownership" has been replaced by the "burden of ownership." You have built significant equity in a rental house, an apartment building, or a commercial strip, but the thought of finding another property, dealing with another round of tenants, and managing another mortgage in this 2026 market feels more like a sentence than an investment.
The Delaware Statutory Trust, or DST, is often the "exit ramp" that seasoned investors use to maintain their wealth without the headaches of active management. In this guide, I am going to walk you through exactly how this works, the strict timelines you have to follow, and the specific IRS rules that can make or break your tax deferral.
Understanding Oil and Gas Royalties
At its core, a royalty interest is a right to a percentage of the revenue generated from the production of oil and gas on a specific property. When you own mineral rights, you own the sub-surface real estate from the "crust to the core".
The beauty of this investment lies in its simplicity for the owner. You are not the "operator." The energy company (the operator) is the one that assumes all drilling risks, pays all operating expenses, and deals with the liabilities. As the mineral owner, you simply receive a monthly royalty check, typically ranging from 15% to 25% of the gross revenue produced, free and clear of any operational costs.
Why Mineral Rights Qualify for 1031 Exchanges
The IRS classifies mineral rights and royalties as real property, making them "like-kind" to traditional real estate like rental houses, land, or commercial buildings. This classification is supported by several authoritative rulings:
IRS Revenue Rulings 55-526, 88-78, and 73-428: These establish that mineral interests are considered real property for federal tax purposes.
IRS Private Letter Ruling 8237017: This ruling specifically states that working interests and overriding royalty interests are properties of a "like kind" because each is a continuing interest in real property.
Because they are deeded and titled assets, you can exchange "out of" a traditional apartment building and "into" a portfolio of mineral rights to defer your capital gains taxes.
The Benefits of Trading Dirt for Minerals
Investors often pivot to royalties for several strategic reasons:
Passive Cash Flow: Royalties provide monthly income without the "three Ts" of real estate: tenants, toilets, and trash.
No Debt or Leverage: Unlike many real estate deals, these investments typically use no leverage. You hold direct title and have full ownership.
Portfolio Diversification: Moving into energy allows you to exit the traditional real estate cycle and gain exposure to different economic drivers.
Tax-Advantaged Income: Royalty income is eligible for a 15% tax depletion allowance, meaning 15% of your income is sheltered from taxes.
Inflation Hedge: As energy prices rise, your royalty checks naturally increase, providing a built-in hedge against inflation.
| Feature | Royalties | Delaware Statutory Trust (DST) | Tenants in Common (TIC) |
|---|---|---|---|
| 1031 Eligible? | YES | YES | YES |
| Debt/Leverage | No leverage is used or accepted | Leverage is often used & accepted | Leverage is often used & accepted |
| Ownership Structure | Direct Title: Investors hold full ownership | Beneficial Interest in Trust | Full Ownership of pro-rata share of title |
| Liquidity & Control | Full Control: Owners manage their own liquidity | Controlled by Sponsor: Traditional lock-ups | Control of undivided interest only |
Sources: Internal Revenue Code Section 1031, IRS Revenue Ruling 2004-86, and Revenue Procedure 2002-22.
Jerry’s Insight
You are not the "operator." The energy company (the operator) is the one that assumes all drilling risks, pays all operating expenses, and deals with the liabilities. As the mineral owner, you simply receive a monthly royalty check, typically ranging from 15% to 25% of the gross revenue produced, free and clear of any operational costs.
Risks to Consider
No investment is without risk, and energy royalties are no exception. You should be aware of:
Commodity Price Volatility: Your income fluctuates based on the market price of oil and gas.
Operator Dependence: You are reliant on the energy company to keep wells in production and drill new ones.
Illiquidity: While you own the deed, selling mineral rights can take more time than selling a residential home.
Variable Production: Production rates can vary by region, and there is no guarantee that additional drilling will occur.