Tax Advantages
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Domestic Oil and Gas Production Favored In The Tax Code
The costs associated with drilling an oil and/or gas well are separated into three components: intangible drilling costs, tangible drilling costs, and lease or operation costs. Under the Tax Cuts and Jobs Act of 2017, the tax code allows investors to write off 100% of all investment costs in the year the investment is made – including tangible, intangible and lease costs – with a deduction limit of $1,000,000 without regard to the outcome of the drilling effort.
Striking Oil
The main benefits of investing in oil include:
When it comes to tax-advantaged investments for wealthy or sophisticated investors, one investment class continues to stand alone above all others: oil. With the U.S. government’s backing, domestic energy production has created a litany of tax incentives for both investors and small producers.
Several major tax benefits are available for oil and gas investors that are found nowhere else in the tax code. Read on, as we cover the benefits of these investments and how you can use them to fire up your portfolio.
Intangible Drilling Costs
These include everything but the actual drilling equipment. Labor, chemicals, mud, grease and other miscellaneous items necessary for drilling are considered intangible. These expenses generally constitute 80% to 90% of the total cost of drilling a well and are 100% deductible in the year incurred.
Tangible Drilling Costs
Tangible Drilling Costs, or TDC’s include capitalized and depreciated equipment and comprise 15 to 20 percent of total costs. These costs are 100% deductible in the year they are incurred.
Active vs. Passive Income
The tax code specifies that a working interest (as opposed to a royalty interest) in an oil and gas well is not considered to be a passive activity. This means that all net losses are active income incurred in conjunction with well-head production and can be offset against other forms of income such as wages, interest, and capital gains.
Small Producer Tax Exemptions
This is perhaps the most enticing tax break for small producers and investors. This incentive, which is commonly known as the “depletion allowance”, excludes from taxation 15% of all gross income from oil and gas wells. This special advantage is limited solely to small companies and investors. Any company that produces or refines more than 50,000 barrels of oil per day is ineligible. Entities that own more than 1,000 barrels of oil per day, or 6 million cubic feet of gas per day, are excluded as well.
Lease Operating Costs
Lease Operating Costs (aka Lease Operating Expense or LOE) includes the costs associated with operating the well or wells and maintaining the lease. This includes, but is not limited to lease purchases, expenses, accounting and administration. These expenses are 100% deductible in the year they are incurred.
Alternative Minimum Tax
The excess intangible drilling costs have been specifically exempted as a “preference item” on the alternative minimum tax return.