Exchanges of Water Rights: “Water Rights Qualify for Tax Deferral in Many States”

The range of types of real property which can be exchanged under IRC Section 1031 as qualifying “like kind exchange” property is extremely broad. Any real property held for productive use in a trade or business or for investment – whether improved or unimproved – can be considered a “like kind exchange.”

 

WHAT ABOUT WATER RIGHTS?

It is important to look to the treatment of water rights under the applicable state laws. In many states, however, water rights are treated as real property and should generally qualify for an exchange of other like-kind real property for IRC Section 1031 purposes.

 

TYPES OF WATER RIGHTS

  • Riparian Right: A) Cannot be lost by non-use; B) Rights in water arise from, and only from, ownership of land which adjoins or underlies a stream; C) Can only be used on the riparian tract.
  • Prior Appropriation: A) Follow the mining laws concept; B) The first to use the water is protected against later water takers; C) Allows maximum use of water resources; D) Provides more flexible water usage.
  • Under the “Prior Appropriation” system, a water right gives an individual the right to use a maximum quantity of water from a specific resource, at a specified point of diversion or withdrawal, for a specified use, and a specified time. The right has a particular “priority” in relation to other water rights from the same source and the priority is the order of ranking in which the owner of the right many take his/her entitlement. The first in time is the first in right. A senior water right has priority over a junior water right.

DETERMINING THE VALUE OF WATER RIGHTS

  1. Beneficial, Consumptive and Historical Uses Beneficial use is sometimes defined as “that amount of water which is reasonable and appropriate under reasonably efficient practices to accomplish without waste the purposes for which the appropriation is lawfully made.” Consumptive use is the amount of water beneficially used and not returned to the stream system and how much water can be used without creating injury.
  2. Reliable Yields Reliable yields are based on engineering studies and past climate and hydrology data. The reliable yields may be affected when place of use and/or type of use is altered.
  3. Marketability of the Water Right The location, size, priority, transferability and quality of the water right.
  4. Intent of the Purchasers Intended use.

To learn more about water right and water right title insurance, contact Stewart Water Information, LLC (888) 353-6760 or www.stewartwater.com