Oil and Gas Investment Tax Benefits

Oil and gas tax deductions apply to both the exploration and development phases of a project. With proper planning, investors may use intangible drilling cost (IDC) deductions and tangible drilling cost amortizations to reduce their gross income.

Additionally, some tax credits are available that allow individuals who invest in new oil exploration or other similar projects to receive a credit against their income tax liabilities.

Special provisions in the U.S. tax code allow investors in certain Oil and Gas ventures to exclude a portion of their profits from taxation when certain conditions are met. 

Consult your tax advisor for more detailed information.

The Tax Reform Act of 1986 ensures that oil and gas working interests are not classified as passive income—making it one of the few investment classes where losses can offset active income like salaries and business profits. The benefits of investing in oil and gas are substantial:

Accordingly, the following potential tax advantages are exclusive to the Oil and Gas industry:

• Intangible Drilling Costs: 100% tax deductible during the year incurred. 
• Tangible Drilling Costs: 100% tax deductible over the life of the oil well.
• Depletion Allowance: 15% of gross production revenue is tax-free over the life of the oil well.
• Active Income Deductions: May offset income from salaries, capital gains, and business revenue

Intangible Drilling Cost (IDC) is a term used to describe the costs associated with drilling and completing an Oil or Gas well, but that don't typically have a physical component. These types of costs are referred to as "intangible" because they do not involve the production of any tangible asset such as materials or equipment. Examples of IDCs include mobilization fees, drill pipe rental fees, rig and crew wages, site preparation costs, mud and cement services, inspection and testing fees, land access fees, hauling services, and other related costs. 

In an Oil and Gas drilling project, a large portion of the investment is considered IDC, which may be 100% deductible during the year incurred. The amount of tax deduction for IDC will vary depending on the nature of the drilling project.

Tangible Drilling Development and Completion Cost (TDC) represents the physical components used in drilling and completing a well, such as drill bits, pipe, casing and cement. These items are intended to be used for several years before they need replacement or must be upgraded due to changing market conditions.

The total amount of an investment allocated to TDC may be amortized and depreciated over 5-7 years because of the nature of the asset. 

TDC greatly benefits Oil and Gas investors by giving them figures that allow them to gauge potential returns on their investments and compare different drilling projects in terms of cost-effectiveness.

The 1990 Tax Act introduced additional tax benefits of investing in oil and gas for individual investors through the Small Producers Exemption. 

The Small Producers Exemption allows:

• 15% of any investors gross production income from oil and gas production to be TAX-FREE over the life of the well 

• Availability only to small producers (not refiners, retailers, or those with large production volumes) 

This percentage depletion exemption can add considerable value over time.

This unique tax benefit is not available to large companies or taxpayers who sell oil or natural gas through retail outlets or those who engage in refining crude oil with runs of more than 50,000 barrels per day. It is also not available to investors owning more than 1,000 barrels of oil or 6,000,000 cubic fee of gas average daily production. The Joint Venture's drilling operations will qualify for “Percentage Depletion” tax benefits. In order to maximize this tax advanted investment class, each investor’s annual tax return should claim “Small Producers Exemption”, if applicable.

A major tax advantage of Oil and Gas investments in an entity that owns working interest is that a working interest is classified as active income, not passive. The Act prohibits the offsetting of losses from passive activities against income from active businesses. The Act provides that a working interest in an Oil and Gas drilling program is not “passive” activity. Accordingly, deductions can be offset against income from business income, salaries, etc.

* Investors should contact their personal tax advisors and review tax aspects in the Confidential Information Memorandum.  IRS CIRCULAR 230 NOTICE: The statements contained herein are not intended to and do not constitute an opinion as to any tax or other matter.  Any statement contained in this communication (including any attachments) concerning U.S. tax matters is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.