By Christina S. Porter

Diversification is one of the keys to preserving investor dollars while enjoying the benefits of investing in real estate. The advent of Tenant in Common (TIC) properties that are 1031 compliant has greatly increased the ability of investors to diversify their portfolio.

TIC ownership presents an opportunity to build a portfolio from different investment categories, different geographical areas and different levels of risk. That can provide the investor with good cash flows — 7 percent to 10 percent — with attractive appreciation potential while minimizing risk.

In an effort to increase cash flow and further diversify, many investors are considering oil and gas royalty properties. Currently these investments offer first year cash flows of 12 percent to 20 percent with healthy depletion allowances to help shelter income. Historically, court rulings have affirmed that oil and gas royalties qualify as “like kind” for a 1031 exchange. It is important for 1031 exchange investors to verify that the oil and gas investment they are considering is 1031 compliant.

The issue for oil and gas typically is if a “production payment” is considered personal property, which or may or may not qualify for a 1031 exchange. A “royalty interest,” which is sometimes known as an “overriding royalty,” is generally 1031 compliant. The difference between production payments and royalty payments is the amount of time an interest is held. A production payment usually terminates when a specified amount of oil or gas has been produced or a stated amount of proceeds have been received. A royalty interest continues until the oil or gas deposit has been exhausted.

The higher return on an investment in oil and gas is attractive to investors because of the strong potential cash flow and tax advantages. It is important to remember that the higher return reflects higher risk.

(You can reach Christina Porter at 1-877-4 TM 1031 or e-mail her at christina@tm1031exchange.com.)