Tax Advantages of Domestic Oil and Gas Investments
It is essential for the investor to calculate their tax position before considering an Oil or Gas (O&G) investment. One of the most significant cost features in oil and gas investing is the effect of federal income tax legislation. It is important that an investor understands the tax advantages in order to fully appreciate the benefits of investing in oil and gas exploration and production. Briefly stated, the investor uses a portion of their tax dollars for investing instead of sending that money to the government for yearly income tax payment. This tax break is given as an incentive to encourage new drilling ventures within the United States.
EXAMPLE: If an individual invests an amount of money in an oil or gas drilling venture, they are allowed to write off all of the Intangible Drilling Costs (IDC) during the first year. The IDC usually accounts for 65% to 80% of the total investment. The remaining percentage must be written off over the next five to seven years. Eventually the entire investment will be written off. The tax savings are achieved with or without any loss of capital. In addition to tax money saved up front, the depletion allowance for oil and gas states that $0.15 on every gross dollar returned to the investor is NON-TAXABLE money starting the second year through the entire life of the wells. Investing in oil and gas not only creates a tax shelter, but also generates a tax-sheltered income.
In 1986 Congress provided tax incentives to stimulate domestic E&P (Exploration and Production) financed by private investment. With the passage of the Tax Reform Act of 1986, oil and gas are one of the most tax-advantaged investments. The act specifically exempts oil and gas working interests owners from being classified as "Passive Income" (Section 469c3 Tax Code.)
FEDERAL INCOME TAX
The basic tax considerations involved in an oil and gas drilling programs are as follows:
Producing Well: Generally your investment includes what are known as intangible drilling costs (IDCís) and they may be written off your ordinary income in the first year. IDCís include labor intensive costs such as the drilling contractor and professional services which are reported to the investor at the end of the each year via K-1 information.
Generally your investment also includes Tangible Drilling Costs which are depreciated over a five to seven-year period using the Accelerated Cost Recovery System (ACRS). Tangible drilling costs include pipe, storage tanks, and wellhead equipment, capitalized and depreciated.
Percentage Depletion Allowance: Currently 15%, making fifteen cents of every gross income dollar non-taxable, thereby producing tax sheltered income.
Dry Hole: 100% of all dollars invested are written off as a loss against your ordinary income in the first year.
AGAINST ORDINARY INCOME
Essentially, an individual who is in a high tax bracket can save as much as $13,000 to $15,000 cash off their annual tax payment on an investment of $50,000, or about $6,500 to $9,000 on an investment of $25,000, and so on. The tax savings can be substantial and unlike many investments, an oil and gas joint venture does not require active participation in order to receive tax benefits.
WARNING:Oil and Gas and securities laws change frequently. This is not intended to provide legal, investment or tax advice in any way. Please contact a CPA pertaining to your particular situation.
PINNACLE EXPLORATION, INC.