- Income – partially sheltered
- Tax Advantages – 80-100% tax deduction on investment and reducing AMT
Why Invest in Oil & Gas?
From global population growth, developing nations, dependence on foreign oil, “Demand growth is highest in the developing world. World demand for oil is projected to increase 37% over 2006 levels by 2030, according to the US-based Energy Information Administration’s (EIA) annual report”—Wikipedia.org
The entire world’s use of oil has been calculated at around 85 million barrels per day. Nations such as Russia, China, India and others who rely heavily on oil imports for their growing economies and populations have put huge pressures on the world consumption rate.
Tax Advantages of Oil and Gas Drilling
*THIS IS NOT TAX ADVICE. PLEASE CONSULT YOUR TAX ADVISOR
Congressional Incentives Encourage Domestic Petroleum Development
Oil and natural gas from domestic reserves helps to make our country more energy self-sufficient by reducing our dependence on foreign imports. In light of this, Congress has provided tax incentives to stimulate domestic natural gas and oil production financed by private sources. Drilling projects offer many tax advantages and these benefits greatly enhance the economics. These incentives are not “Loop Holes”–they were placed in the Tax Code by Congress to make participation in oil and gas ventures one of the best tax advantaged investments.
Intangible Drilling Cost Tax Deduction
The intangible expenditures of drilling (labor, chemicals, mud, grease, etc.) are usually about (65% to 80%) of the cost of a well. These expenditures are considered “Intangible Drilling Cost (IDC)”, which is 100% deductible during the first year. These deductions are available in the year the money was invested.
Tangible Drilling Cost Tax Deduction
The total amount of the investment allocated to the equipment “Tangible Drilling Costs (TDC)” is 100% tax deductible. In the example above, the remaining tangible costs may be deducted as depreciation over a seven-year period.
Active vs. Passive Income
The Tax Reform Act of 1986 introduced into the Tax Code the concepts of “Passive” income and “Active” income. The Act prohibits the offsetting of losses from Passive activities against income from Active businesses. The Tax Code specifically states that a Working Interest in an oil and gas well is not a “Passive” Activity, therefore, deductions can be offset against income from active stock trades, business income, salaries, etc.
Small Producers Tax Exemption
The 1990 Tax Act provided some special tax advantages for small companies and individuals. This tax incentive, known as the “Percentage Depletion Allowance”, is specifically intended to encourage participation in oil and gas drilling. This tax benefit is not available to large oil companies, retail petroleum marketers, or refiners that process more than 50,000 barrels per day. It is also not available for entities owning more than 1,000 barrels of oil (or 6,000,000 cubic feet of gas) average daily production. The “Small Producers Exemption” allows 15% of the Gross Income (not Net Income) from an oil and gas producing property to be tax-free.
Risks of Oil and Gas Investing
- Prices of oil and gas are highly volatile
- Reserve estimates are not an exact science
- Difficult to leverage
- Alternative energy sources
- Production expenses
- No return of principal; only cash flow to the investor.
Lease costs (purchase of leases, minerals, etc.), sales expenses, legal expenses, administrative accounting, and Lease Operating Costs (LOC) are also 100% tax deductible through cost depletion.
Alternative Minimum Tax
Prior to the 1992 Tax Act, working interest participants in oil and gas ventures were subject to the normal Alternative Minimum Tax to the extent that this tax exceeded their regular tax. This Tax Act specifically exempted Intangible Drilling Cost as a Tax Preference Item. “Alternative Minimum Taxable Income” generally consists of adjusted gross income, minus allowable Alternative Minimum Tax itemized deduction, plus the sum of tax preference items and adjustments. “Tax preference items” are preferences existing in the Code to greatly reduce or eliminate regular income taxation. Included within this group are deductions for excess Intangible Drilling and Development Costs and the deduction for depletion allowable for a taxable year over the adjusted basis in the Drilling Acreage and the wells thereon.
Please note that this is not an appropriate investment for all investors, Please call us to discuss.