A Discussion About Tax Advantages Regarding Oil and Gas Investing:
The following general discussion is provided for background information only. You should always consult with your personal Tax Advisor as to your individual tax consequences before investing in a drilling project. State Income Taxes could add additional tax savings.
In 1986, we witnessed the passage of the "Tax Reform Act". This passage left Oil and Gas investments as one of the most tax advantaged investments you can have in your portfolio. This Act did specifically exempt oil and gas Working Interest from being classified as "Passive Income". This means that all deductions can be used to offset your "active" or "ordinary" income. (See section469(c), (3) of the Tax Code.
INTANGIBLE DRILLING and DEVELOPMENT COSTS: "IDC's"
- All incidental and necessary items to the drilling and preparation of well(s) for the production of Oil and Gas. Work performed by contractors, cost of labor, fuel, hauling, supplies, etc., under any form of contract, including turnkey contracts, become your IDC. The IDC does NOT include the pipe and equipment that becomes part of the well. The IDC recently has been 85% of the total investment. For example: and investment of $50k with an 85% IDC could result in a tax write-off of $42,500. An individual in the 39.6% tax bracket could be saving $16,830 on federal taxes alone!
TANGIBLE DRILLING COSTS (Well Equipment)
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Tangible drilling costs (Well Equipment) attributed to the venture is computed and reported as depreciation as an expense on the tax. The difference between the total investment and the IDC would be the amount subject to depreciation. A straight line depreciation over a 5 year period is used generally.
DEPLETION ALLOWANCE
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As the Oil/Gas is pulled from a formation, the reservoir becomes depleted. The rate for percentage depletion deduction ranges from 15% to 25% depending on production rate, and wellhead price. This allowance helps the owner(s) of a producing well or wells to recover their investment during the period in which Oil and or Gas is being produced. The depletion allowance in any year cannot exceed 65% of the tax payers taxable income from all sources.
OPERATING and PRODUCTION COSTS
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These costs, including but not limited to: pumping costs, well maintenance costs, transportation costs, insurance, tax preparation, bank fees, filing fees, and any other expense associated with the production of income from an oil/gas well are 100% deductible in the year the costs occurred.
The above are actual deductions, NOT credits, or deferments to be recaptured later as with most investments.
To Summarize this discussion about the exclusive tax advantages of oil/gas investing would be to say:
1.) If you lose in an o/g venture (Dry Hole)= 100% principal deduction as a loss, in the year occurred.
2.) If you win in an o/g venture= Currently, 85% of your principal investment is deducted the 1st year, 5% each year for the next three = 100% principal deduction. Remember the IDC deduction in above discussion?
3.) The "Depletion Allowance" allows 15- 25% of your profit share check amount to be deductible.
4.) Always consult your Tax Professional to get the latest allowable percentages of IDC's and the Depletion allowance which varies as mentioned in the discussion above.