Tax Advantages of Oil and Natural Gas Investments


Sophisticated investors are always looking for the best returns on their investments, and one way they do this is by seeking out opportunities offering robust tax advantages. Thanks to US government intervention, domestic production of natural gas and oil offers tax breaks for both producers and investors. In fact, natural gas and oil investment offers tax benefits not found anywhere else in the tax code.


oil & natural gas tax advantages

Part of the reason is because the US government wishes to encourage domestic production of energy sources such as natural gas and oil. Doing so reduces reliance on foreign fuels. To encourage domestic production, the government is willing to offer generous advantages to investors, who are needed to develop the domestic industry.


Right now, investing in natural gas and oil can be especially lucrative. To get the best advantages and to make smart investments, however, you need resources not only about savvy investments but also about natural gas and oil investments. Investments in this field are truly not like any other, so you need support in this sector.


Fortunately, our team has over 40 years of combined investment and oil and gas experience. We offer the powerful resources and up-to-date information you need to make smart moves with your portfolio. If you’re interested in entering one of the most exciting investment opportunities of recent years, contact us for a free consultation today.


Gas and Oil Investment Tax Deduction Options


Investors interested in oil or natural gas can realize many deductions and tax advantages, including:


1) Deductions for tangible drilling costs:


Tangible costs related to drilling — such as the costs of equipment used for drilling — have to be depreciated over a schedule of seven years. However, investors enjoy a 100% deduction on these costs.


2) Deductions for intangible drilling costs:


All intangible drilling costs, including labor, are a write-off in the first year they are incurred, as long as the well is operational by March 31 of the following year. This deduction can be especially important for investors, since intangible costs tend to account for 65-80% of oil well drilling. Intangible drilling costs can include expenses associated with employees, mud drilling, supplies, chemicals, the fracking process, crews and most expenses except for the actual drilling equipment (which is considered a tangible cost).


oil well drilling intangible costs

In addition, since tangible cost deductions cover oil well drilling equipment and intangible cost deductions cover most or even all other costs, it’s possible to have most of the cost of drilling a well remain deductible. This is the case even if the drilling doesn’t produce oil. The deductions are not linked to oil production or performance.


It is far less common for a company to drill and not find oil or gas, as new technologies allow companies to locate high-probability areas for drilling before work begins. However, even if a site does not prove as profitable as hoped, deductions mean investors who have contributed a principal still get tax breaks, which reduce overall tax burdens.


3) Lease cost deductions:


As long as these expenses are written off via a depletion allowance over the term of a lease and are capitalized, it’s possible to deduct the costs associated with buying mineral rights and lease rights. Lease cost deductions also include accounting costs, administrative expenses and lease operating expenses related to acquiring leasing and mineral rights.


4) Depletion allowance for small producers:


This tax exemption for small producers and investors allows 15% of all gross income from gas and oil wells to be excluded from taxation. For example, if an investor receives $10,000 from their oil and gas investment, $1,500 of that number is tax-free.


gross income from gas & oil wells

To qualify, you need to be a small producer of less than 50,000 barrels a day, or must own fewer than 1,000 barrels of oil a day, or less than 6 million cubic feet of natural gas per day. The depletion allowance is intended to be similar to the allowance permitted for deprecation for real estate: it is intended to address the gradual depletion of oil and natural gas at a site over time.


Also known as the Percentage Depletion Allowance, this incentive was created under the 1990 Tax Act and is especially beneficial to new and smaller investors. It was created specifically to entice investors into drilling for natural gas and oil.


5) Passive and Active Income Deductions:


The Tax Reform Act of 1986 prevents taxpayers from offsetting losses from passive income against active income. Since working interests in natural gas and oil wells are defined as an active income activity for tax purposes, losses for investors in these fields can be deducted against business income, capital gains, interest income, salary and other active income sources.


6) Alternative Minimum Tax:


Since 1992, any excess intangible drilling and development costs, as well as deductions for depletion allowable for some drilling acreage and wells, are exempt for investors on the alternative minimum tax return as a “tax preference item.”


7) Tax advantages for marginal wells:


A bill passed by the House of Representatives and the US Senate grants tax credits to a maximum of $9 per day, per well, for marginal oil and natural gas wells. Also known as stripper wells, marginal wells pump an average of 90,000 cubic feet of natural gas or 15 barrels of crude oil daily. These wells account for up to 10% of gas and 25% of crude oil produced in this country.


crude oil produced in the USA

The tax bill was passed because a growing number of stripper wells have been plugged permanently with cement, and the US government wants to protect remaining marginal wells.


8) 1031 Exchanges:


Another option is to get more from a natural gas or oil investment as a 1031 exchange. This like-kind asset swap allows you to sell a business or investment real estate property and get tax advantages without putting your money back into the real estate market.


9) Enhanced recovery credit:


Over time, as oil is recovered from a field, it becomes more difficult and costly to extract oil because pressure in the well decreases. As production declines, there is still usually oil in the well and the government wants to encourage the use of different methods to extract the remaining oil. Therefore, the government offers the enhanced recovery credit of 15%.


If you own an operational mineral interest and have qualified costs related to enhanced recovery efforts, you can claim these credits during the year they are incurred. You may qualify if you are using chemical, steam or carbon monoxide methods in an attempt to extract more from a field.


What is notable about these tax benefits and exemptions is that there are few limits. In fact, the only limit is the small producer limit, meaning tax benefits from investing in oil and gas drilling are a great option even for very wealthy investors. As long as investors own less than 1,000 barrels of oil a day, they can reap all or most of the tax benefits listed above.


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tax advantages of oil investments


Tax Benefits by Investment Type


While there are many tax benefits to be realized from investing in oil drilling and natural gas, the tax advantages enjoyed will vary depending on the investment type. There are five major types of investments in these two sectors:


1) Partnerships:


Many investors select limited partnerships for oil and natural gas investments, as these formations limit liability to the extent that an investor has invested. Tax advantages are available to partnerships on a pass-through basis and allow investors to avoid double taxation. Taxes will be largely reliant on the investments and revenues made from the partnership. Since there are risks in these industries, the SEC (Securities and Exchange Commission) asks most natural gas and oil partnerships to be accredited.


If you’d like to invest in gas and oil largely for tax advantages, partnerships can offer some of the most robust tax breaks. However, partnerships vary widely and you will need to research carefully to realize the most tax advantages. For example, private partnerships allow you to own part of the oil and gas produced, as well as assets while MLPs (Master Limited Partnerships) are traded securities.


In the best-case scenario, investment in a partnership can offer a considerable deduction in the first year of investment and tax-advantaged income in subsequent years. Since a good partnership can produce income and profits for years, investors can potentially realize returns and tax advantages over decades.


2) Royalties:


Royalties are paid to those who own land where oil and natural gas is found and drilled.


field

Landowners do not assume liability and can earn 12-20% in royalties on gross production. However, these royalties are reportable and landowners only get tax breaks if they invest actively in production or in some other way.


3) Mutual Funds:


Mutual funds require investors to pay taxes for capital gains and dividends. Investors only get tax advantages by investing in some other manner.


4) Working Interests:


Income from working interests must be reported on Schedule C of the 1040 Form and is subject to self-employment tax, although most investors who have working interests earn enough to go above the taxable wage base. Working interests are eligible for many tax breaks.


5) Stocks and ADRs (American Depositary Receipts):


You can invest in companies drilling for oil and natural gas. Large oil companies, in particular, are often publicly traded companies, and buying shares can be as simple as contacting your broker. While you will not get tax breaks directly for becoming a shareholder, you may also experience less risk with stocks and ADRs than with direct investment. In addition, the company you are investing in is likely getting tax advantages for their oil or gas production, and this can indirectly help the value of your stocks by potentially improving company profitability.


Maximizing Tax Benefits From Investing in Natural Gas Drilling


If you’d like to invest in natural gas and oil, there are several ways to maximize your tax benefits:


1) Learn about investments and about oil and gas investments specifically.


Oil and gas investments are for savvy and experienced investors. To maximize your tax benefits, you need to know how to invest correctly, and to do this you need due diligence.


oil investing chart

You can learn more by contacting OilScams.org for a free consultation to learn about gas and oil investments. OilScams.org offers personalized support as well as a wealth of resources for investors.


2) Talk to your tax advisor.


The tax advantages you realize from gas and natural investments will depend in part on your tax situation, and your tax professional can best advise you about that. In addition, if you are investing in natural gas and oil specifically to deduct against your passive income or for a 1031 exchange, you will want to consult with a tax professional who can advise you about whether these options are possible in your specific situation. Consider ordering a tax projection, which can help you evaluate how tax advantages can affect your filings in the coming years.


You will also want to ask your tax advisor how your investments may affect how you file taxes. You may be asked to file taxes in different states, or you may have to file at different times of the year. If you have a tax professional assisting you, they may need to know your plans ahead of time so they are prepared.


3) Talk to professionals.


Get a personalized plan from a professional familiar with your investment portfolio. If you already have investments and could use the tax advantages of oil and gas investments, for example, a professional can guide you to the types of investments you need to gain your best tax advantages. Talking to a professional is also important because tax rules and incentives change. You want to ensure you are making investment choices based on current tax breaks.


To get support and advice as you enter the exciting world of gas and oil investment, contact OilScams.org for a free consultation with professionals who have more than 40 years of combined experience in this sector.


4) Diversify your investments.


Oil and gas prices increase and decrease over time.


oil drums

Tax breaks and advantages offered to investors in this field can help shelter you from some of the changes in prices, since you will continue to get some tax breaks regardless of oil prices and well conditions. However, to protect yourself further, you will want to build a diversified portfolio that is balanced to enhance your investments in all market conditions. Adding some liquid investments or less dynamic investments to your portfolio lets you earn tax benefits and long-term profits from natural gas and oil while also addressing risk.


5) Avoid scams.


Every investment opportunity has scams, and since oil and gas can be so lucrative, they have their share of scams as well. Remember that no one can promise you a “guarantee” on a return on investment and no one can guarantee that you will save a specific sum on your taxes. Your returns and tax breaks will depend on many factors, including your investments, your state of residence, what you invest in and market conditions.


6) Understand functional allocation.


Many investors choose to invest in partnerships, since, in the gas and oil sector, these can yield considerable tax advantages. Each partnership will have a drilling program and will allocate intangible and tangible drilling costs to investors based on this program. An investor may receive an allocation of some tangible drilling costs and a percentage of intangible drilling costs, or may be allocated 100% of intangible drilling costs.


oil rig in ocean

It is important to review the drilling program you are interested in to see how allocation works, especially since tax advantages are different for intangible and tangible costs. While disproportionate allocation is permitted, the partnership must have use allocation rules that will stand up to IRS scrutiny.


7) Decide when to deduct intangible drilling costs.


When an investor invests in a drilling program within a partnership and has some intangible cost deductibles, they can elect to deduct the allocated intangible costs in the year of investment, or they can choose to amortize the deduction over five years. They can also choose to capitalize and deduct the costs over a five-year period after deducting part of the intangible costs in the first year. Each option can have tax benefits for the investor, and investors will want to carefully consider the right choice for them.


8) Determine your role.


If you will be investing in partnerships, realize you can invest as a limited or general partner — and the choice you make will affect your tax benefits. General partners do take on some liability, although they are covered by insurance and work with sub-contractors who also have insurance. To take initial intangible and tangible deductions, you must be a general partner.


After the wells are done, general partners become limited partners. You can also choose to invest as a limited partner from the start. As a limited partner, you enjoy more protection from liability while still enjoying some tax advantages. For example, if you have enough net passive income from other opportunities, you can offset the entire passive deduction from the intangible drilling cost deductions. If you do not have enough passive income from other sources, you may carry the intangible drilling cost passive losses for later tax years.


9) Consider your goals.


Gas wells can keep producing for twenty to thirty years, so by investing in oil or gas, you may be enjoying returns and distributions for some time. Oil and gas can help you diversify your investments and, since prices can increase, leading to even larger distributions, they can be a great choice for someone who wants to add strong profitability potential to a portfolio.


oil gas wells

The tax benefits of gas and oil can also be powerful. In fact, they can be as strong an incentive as high profit potential. For investors in a high income bracket, and for investors who have generated considerable income in the past year, the tax benefits of gas and oil investments can offer legitimate ways to protect revenues and income from higher taxation. Tax benefits from gas and oil investments can also protect future income and can protect an investor’s Social Security benefits by counterweighing higher amounts of earned income. For those who pay higher self-employment taxes, tax benefits from oil and gas investments can balance those taxes and lower estimated payments. In some cases, investors can use tax advantages of gas and oil investments to help qualify for college tuition credits, Roth IRAs or conversions.


You can achieve all these goals by investing in oil and gas, but how you approach investments will depend on your aims. If you have earned higher revenues this year and want tax benefits for this year, for example, becoming a general partner in a partnership may give you more of the deductions you seek. If you wish to protect future earnings, other investment strategies may be more appropriate.


10) Consider track records and number of wells drilled.


When examining a project, carefully consider the experience and track record of those taking part. Look for teams inspiring confidence. Also, look for projects with a higher numbers of wells, since there will be a greater chance some will be profitable. Always read the materials and reports offered to potential investors, as these offer considerable information about the specific investment you are considering.


11) To get more tax benefits, consider more insurance.


In most cases, you will need to have a working interest in gas and oil production or be a general partner in a partnership to get the maximum number of benefits from a tax perspective. You may wish to get additional liability insurance to protect yourself from the additional risk of these endeavors. Talk to your tax professional if you decide to seek additional insurance — your insurance costs may be deductible.


Finding Legitimate Oil and Gas Investments


person sitting at desk

Investing in natural gas and oil can be very lucrative. For a knowledgeable and successful investor, such investments can also offer attractive tax breaks. However, to make the most of these incentives, you need to be moving forward with strong and reliable investment knowledge.


Request an appointment to learn how to invest in oil!

If you’d like to learn more about oil and natural gas investments and their tax benefits, schedule a free consultation with Oilscams.org. With a team that has more than 40 years of combined experience in the investment and oil and gas industries, Oilscams.org has been providing education and resources for investors just like you. Oilscams.org has a solid credit history and a strong D&B paydex listing.

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