Tax Advantages of Investing in Oil & Gas

Oil and Gas development from domestic reserves reduces the United States' dependence on foreign oil imports. As a result, the U.S. government offers tax advantages to Oil and Gas investors in an effort to stimulate production and drive economic growth.

potential tax benefits example

Why Invest in Oil & Gas?

Investing in Oil and Gas presents an alternative opportunity for tax savvy investors to capitalize on a resource that is in high demand for many industries, including transportation, heating, cooling, manufacturing and other energy-intensive activities.

How Investing in Oil & Gas Can Help Investors Lower their Tax Burden

With tax advantages such as deductions for certain costs related to the exploration and development of wells, Oil and Gas investors can reduce their taxable income, which can lead to lower overall taxes owed. 

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.

In addition, special provisions in the U.S. tax code allow investors in 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.

Examples of Potential Benefits of Investing in Oil and Gas

With the passage of the Tax Reform Act of 1986 (the “Act”), Oil and Gas ventures remain one of the few tax-advantaged investments available to American taxpayers. In fact, the Act specifically exempts Oil and Gas working interests from being classified as “Passive Income.” 

In addition to this, the following potential tax advantages are exclusive to the Oil and Gas industry.

  • Intangible Drilling Costs: 100% tax deductible during the first year.
  • Tangible Drilling Costs: 100% tax deductible.
  • Depletion Allowance: 15% of gross production revenue is tax-free.
  • Active Income Deductions can be deducted against business income, salaries, capital gross, interest income, etc.

Intangible Drilling & Development Cost Tax Deduction

Intangible Drilling Cost (IDC) is a term used to describe the costs associated with drilling and completing a 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 paid. The amount of tax deduction for IDC will vary depending on the nature of the drilling project.

Tangible Drilling & Development Cost Benefits

Tangible Drilling Development and Completion Cost (TDC) represents the physical components used in drilling and completing a well, such as drill bits, pipes, casings 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 accurate figures that allow them to gauge potential returns on their investments, compare different drilling projects in terms of cost-effectiveness, and protect themselves from unexpected expenses related to a particular project.

Small Producers Tax Exemption

The 1990 Tax Act provided tax advantages for the typical investor in Oil and Gas drilling projects. This “Small Producers Exemption” allows 15% of any investor’s gross income for an Oil and Gas property to be TAX FREE, subject to certain limitations. The 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 quality for “Percentage Depletion” tax benefits. Each investor’s annual tax return should claim “Small Producers Exemption”, if applicable.

Oil & Gas Investments are not Passive Income

The Tax Reform Act of 1986 introduced the concept of “passive” income and “active” income. 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.

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