Tax Benefits of Oil and Gas Investing
These are the basic tax benefits associated with investing in oil and gas.
NOTE: As always seek proper licensed tax advice for these issues.
Intangible Drilling Cost (IDCs) In the process of drilling a well, there are certain expenses incurred that have no salvage value. They may be labor, drilling expenses, testing, etc. These expenses generally represent from 60 to 75 %percent of the total cost of the well. The investor’s proportionate share of these intangible expenses can be written off in the year in which they were incurred.
Intangible Completion Costs These are treated the same as intangible drilling costs.
Tangible Completion Expenses These usually represent 25 to 40 % percent of the total cost of the well.
Tangible Drilling Cost The total amount of the investment allocated to the equipment is 100% tax deductible. Tangible costs may be deducted as depreciation over a seven-year period. (See Section 263 of the Tax Code.)
Tax Credits Congressional incentives encourage domestic petroleum development. Congress has provided tax incentives to stimulate domestic natural gas and oil production. Several tax credits in relation to oil or natural gas production. The Enhanced Oil Recovery Credit is applied to certain project costs incurred to enhance a well’s oil or natural gas production. This credit is up to 15% of the costs incurred to enhance production. (See Section 263 of the Tax Code.)
Small Producers Tax Exemption The “Small Producers Exemption” allows 15% of the Gross Income (not Net Income) from an oil and gas producing property to be tax-free. This is also known as depletion allowance
Lease Costs Lease costs, sales expenses, legal expenses, administrative accounting, and Lease Operating Costs are 100% tax deductible.
Active vs. Passive Income 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.
Oil and Gas interests are also a type of real property. As such they are appropriate for tax deferred programs like self directed IRA’s and 401k’s. Some projects can even qualify for 1031 tax deferred exchanges.