Marcellus Shale Meets the 1031 Exchange!

The Marcellus Shale is a rock formation lying 5,000 to 9,000 feet below the surface, stretching from New York State through West Virginia of which sixty percent is located in Pennsylvania. Marcellus Shale exploration and drilling has overtaken the northern to southwestern part of Pennsylvania, and with it comes many new challenges and opportunities for the landowners in this area, and 1031 exchanges may help.   

Gas exploration and drilling in this part of the state is not something new to landowners. However, the new technology gas companies have for locating and extracting the gas is. This technology of horizontal drilling and hydraulic fracturing has given the gas companies access to large gas deposits deep within the earth. While technology gives them the ability to locate and remove the gas, there is another hurdle these companies must face before they can actually start any of these processes – access to the land.

Many landowners have been approached by gas companies to lease their land and retain a percentage of the royalties if gas is located. The signing bonuses attached to these offers can be very attractive to the landowner depending on the level of certainty on the part of the gas company and how many companies are competing with the same landowner. While the bonuses are very attractive because they are a guaranteed payment, royalties, in the long run, may pay out more over time.

A lease of 30 years or more, including options, can be exchanged for a fee interest in real property and some mineral leases will qualify for this treatment (Rev. Rul. 68-226). Exchanging into a fee interest in real property simply means the landowners may exchange their qualifying lease into any type of real estate held for business use or investment.  However, the structure of a lease with the landowner retaining a percentage of royalties, does not qualify as real estate due to the fact that the landowner still has an economic interest in the land.

The owner of a mineral royalty does not incur any cost of production and has the right to receive a designated percentage of all minerals produced until exhaustion. A royalty interest is considered a real property interest and can be exchanged for a fee interest in real estate (Rev. Rul. 73-428). Landowners retaining a royalty interest may be able to exchange that interest for other income producing real estate.

Another option gas companies are pursuing is actually purchasing the mineral estate or rights running with the land. In this situation the landowner still retains ownership of the surface real estate, but would be selling the rights to any minerals or gas found beneath the surface. Since there is no remaining economic interest to the landowner, the mineral estate may be exchanged for a fee interest in other real estate.

This type of exploration, drilling and production, not to mention pipeline right-of-ways, is not just limited to the Marcellus Shale areas. Gas companies are working all over the country to find new resources and are creating many opportunities for informed landowners. Exchanging leases, royalties or rights while retaining the use of the overlying real estate, can create more wealth and income if handled properly. There are legal and tax advisors that specialize in advising and negotiating these types of deals for the landowners. 1031 CORP. is here to help the landowner defer the taxes and maximize this new found wealth.