Saturday, March 8, 2008

Eliminate the tax burden for 1031 exchanged real estate by participating in an oil and gas drilling investment

Use oil/gas drilling ventures to reduce or eliminate 1031 exchanged asset's eventual capital gains taxes.
Real estate investors who have deferred capital gains taxes on 1031 exchanged properties may be able to eliminate or drastically reduce capital gains taxes by participating in an oil and gas investment. By selling outside of using a 1031 exchange, the owner can reinvest the capital gains into an oil and gas investment since the full investment is deductible against active and passive income. Lets look at this in more detail.

First let’s provide a quick overview of what a 1031 exchange is.
This is an investment tool that allows usually real estate investors to sell income property without paying capital gains if those funds are invested in a equal or higher cost “like” type investment, usually another income property. However, the tax has only been deferred, not eliminated. Eventually, there will be a time when the sale of the final exchanged property will require payment of capital gains taxes based on the basis value of the original first exchanged property. There is potential for very significant capital gains in these properties resulting in equally significant taxes. There are ways to reduce or eliminate these taxes, but those methods usually require giving up some or all control of the asset or funds.

Consider an example.
As an example, assume an investor has $100,000 in capital gains in an income property and wishes to purchase a more significant income property. If the investor chooses to sell the first property without using a 1031 exchange, then a 15% capital gains tax is due for $15,000, leaving only $85,000 of funds for investment in the other property. If a 1031 exchange is used, then the full $100,000 of capital gains could be invested in the other property. This is a significant advantage while building wealth, but not an elimination of the eventual taxes due.

Exchanging real estate as "like type" investment into a domestic oil/gas drilling venture.
If an oil or gas well project is set up with investors having direct ownership interest, then the offering company may be able to accept 1031 exchange into the associated partnership shares. Oil and gas wells are considered “like” type investments allowing exchange of income properties into participation in the well. One thing to be aware of with any 1031 exchange is there are usually third party fees that can take several percentages of the funds in fees for facilitating the exchange. Therefore, even though you can do a 1031 exchange of real estate into a oil and gas investment, the fees and deferred tax issues may make it a better choice to sell the real estate outside of a 1031 exchange with the proceeds going into an oil and gas investment to get the associated tax benefits mentioned above.

It may make more sense to sell outside of 1031 into a domestic oil/gas drilling venture.
An example will illustrate the benefits of moving previously 1031 exchanged properties into an oil or gas well outside of using a 1031 exchange. For this example, 90% of the invested funds for each participation share in the partnership goes toward intangible drilling costs while the remaining 10% goes toward tangible costs. If the investor sells a property that has $100,000 in capital gains and invests the funds in an oil or gas well, then 90% of the $100,000, or $90,000 is removed from capital gains tax exposure the year of the sale. Only the remaining $10,000 is taxable at a 15% capital gains tax rate for a total tax due of $1,500 for the $100,000 in capital gains. However, the remaining 10% of each share cost can be deducted as tangible costs over seven years. Therefore the $1,500 in taxes is recouped over these seven years.

Bottom line...
As you can see, oil and gas well participation offers real estate investors with large capital gains to remove the associated tax burden for 1031 exchanged properties with capital gains.

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Copyright 2008 Ole Cram. Ole Cram is President of Marcobe Investments, Inc., a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration to also participate. Feel free to email us at with any questions, thoughts, or requests for information on what projects we are invested in.

This article was posted at Accredited Investor Blog: Past articles can easily be found at This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

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