This Information is for General Educational Purposes only. Consult your CPA professional for direct impact on your financial picture.
TAX CONSIDERATIONS – An Overview Summary
Investment in the oil and gas industry provides very significant tax advantages for the Small Producer. Although the Tax \ Reform Act of 1986 eliminated many traditional “tax shelters,” many of the tax advantages associated with participation in domestic drilling programs remain in place. A properly structured program can provide an excellent means of stretching one’s investment dollar.
Consider the following:
- In the case of a successful oil and gas investment, the IRS allows for a tax write-off from one’s taxable earned income of approximately 65% - 80% of the investment amount in the year of investment. The remaining amount of the investment is depreciated over a period of seven years.
- Even in the case of an unsuccessful oil and gas investment, the IRS allows almost 100% of the investment to be written off against one’s taxable earned income unlike stock investments where the investor may only write-off a small portion of the loss (subject to certain limitations).
- The IRS currently allows 15% of one’s gross working interest income from the sale of oil and/or gas to be derived “tax free” from the sale of oil and/or gas (this is referred to as a “depletion allowance”).
- Net income from a producing oil and/or gas well is usually distributed on a monthly basis. This differs from stock investments where the majority of one’s profitable income is derived from the sale of stock. Each check, in effect, serves to reduce the amount initially invested.
- Most importantly, if one’s tax liability is substantial, investment in oil and gas can reduce one’s tax liability, while providing long-term, diversified investment potential.
- Investment in oil and gas exploration and/or field enhancement has the potential to lower one’s taxable income bracket in the following ways:
- Approximately 65% to 85% of the initial investment is classified as “Intangible Drilling Costs” (IDC’s) and may be deducted from one’s income in the year the investment is made, subject to certain limitations (see pages 28-29 in IRS publication 535, catalog 15065z).
- Approximately 15% to 30% of the amount of one’s investment is allocated to leasehold equipment “Tangible Drilling and Completion Costs” (TDC’s) and may be deducted from one’s income over a 7-year period.
- Leasehold costs (the cost of the lease on which the subject well is drilled), sales expenses and organizational costs can amount to approximately 10% to 15% of the investment and may be recovered through Costs Depletion (CD Items).
- Oil and gas income is subject to a 15% statutory depletion allowance, subject to certain limitations.
- If the well is unsuccessful and/or abandoned all of the costs may be deducted from one’s income in the year of that occurrence, subject to certain limitations