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Understanding the Tax Breaks

Top Three Tax Deductions for Oil and Gas Investments

The oil and gas industry enjoys some of the most lucrative benefits available in the U.S. tax code. Starting in 1986, the Federal Government introduced unique tax deductions for investors who directly fund oil and gas wells. Thanks to a new law in place from 2018 – 2023, you can now deduct up to 100% of the well cost in year one of the investment. 

For more than three decades, wealthy Americans have used these deductions to reduce their taxable income. Instead of sending a check to Uncle Sam, they’ve put that money towards drilling oil and gas wells. The tax code also offers the opportunity to protect the future income from those wells. The end result: a lower tax bill today, and the potential for years of tax-advantaged income streams in the future. 

Here are the top three ways you can take advantage of these opportunities.

INTANGIBLE DRILLING COSTS TAX DEDUCTION

The non-recoverable expenses of an oil and gas well are known as “intangible drilling costs” (IDCs). These include things that you can’t resell later including fuel, drilling fluids, and wages. IDCs typically make up roughly 65 – 80% of the well cost, and you can deduct 100% of IDCs in year one of the project. 

For example, if you make a $100,000 investment into a well with 75% IDCs, you could earn up to a $75,000 deduction against your income tax bill. You also get a little leeway with the timing. IDC deductions become available in the year the money gets invested, even if the well does not start drilling until March 31 of the following year. (See Section 263 of the tax code.)

TANGIBLE DRILLING COSTS DEDUCTION

Tangible drilling costs (TDCs) refer to the well costs that you can potentially recover, including wellheads, tanks, leaseholds, etc. TDCs typically make up between 20 – 35% of drilling expenses, and they are also 100% tax deductible. 

In the past, tax rules forced investors to take TDC deductions over a seven-year depreciation schedule. But thanks to a new 2018 law in effect until 2023, you can now deduct 100% of the TDCs in the first year. So instead of having to apply these tax savings over seven years, you can now bring forward 100% of your TDC deductions into the current tax year.

The end result for investors is that, through at least 2023, you can now deduct up to 100% of the upfront cost of drilling a well from your current year taxes. But that’s not all – as an individual investor, you can enjoy even greater tax benefits after drilling the well when the production comes online.

DEPLETION ALLOWANCE

The 1990 Tax Act allows energy producers under a certain volume limit to exempt 15% of their gross income from federal taxes. The incentive is designed to support independent energy producers and individual investors.

Here’s how it works…

The Depletion Allowance applies to small companies that produce no more than 50,000 barrels per day of oil. As an individual investor, you qualify for the Depletion Allowance if your share of production falls under a threshold of 1,000 barrels of oil per day or 6,000 cubic feet of gas per day.

Liability

EnergyFunders offers the unique opportunity of investing as an active or passive participant in our Funds. As an active investor, you can deduct your investment from active income, including regular wages. If you invest as a limited partner, you can only deduct your investment against passive income (i.e. stock dividends or bond interest payments). 

Importantly, active investors take on unlimited liability versus limited partners that have limited liability. We encourage every individual to consider their own risk tolerance and tax situation in choosing which option makes the most sense for their personal situation.