Powerful Tax Benefits of Oil and Gas Investing

Intangible Drilling Costs (IDCs) are the non-salvageable expenses associated with the drilling phase of a well, such as labor, fuel, and hauling. Meanwhile, Intangible Completion Costs (ICCs) are the non-salveable expenses associated with the completion phase of a well. IDCs and ICCs are similar in that they include expenses incurred that have no associated salvageable items. IDCs and ICCs include things like labor, mud, operations, grease, chemicals, and essentially anything other than the equipment itself. The primary difference between IDCs and ICCs is the timing, with IDCs being the costs associated with the drilling process and ICCs being the costs associated with bringing the well to production following drilling.

As you can imagine, this accounts for a significant tax deduction opportunity. Resources from the Committee for a Responsible Federal Budget reveal that Intangible Drilling Costs and Completion Costs are 100% tax-deductible when claimed in the same year as purchased, as long as drilling begins on or before March 31st of the following year.[1]

At the other end of the spectrum, Tangible Drilling Costs and Completion Costs are the hard expenses that could have a salvage value. This includes any equipment used in drilling and development, such as pipes, steel, rigging, drill bits, cementing equipment, and more.

The costs to acquire these assets are 100% deductible over a 7-year period. This reduces your overall tax burden over a predetermined amount of time and creates liquidity in your account instead of handing over more of your hard-earned resources to the Government.

At the tail end of the last century, in 1990, the Tax Act provided special tax advantages for small operations and individual investors. These advantages carry over into direct participation in oil and gas wells, which allows up to 15% of gross income from the property to be tax-free.[2]

Officially labeled the Percentage Depletion Allowance, it was created in part to inspire more participation in U.S. oil and gas drilling and reduce reliance on foreign supply. Any stakeholder in a mineral deposit or natural gas reserves can claim this allowance and be reimbursed for the extraction of natural resources via tax breaks.

This does not apply to the huge corporate conglomerates, however. Any operation that produces more than 50,000 barrels per day or owns more than 1,000 barrels of oil of average daily production is ineligible to receive this exemption.

The recurring costs of operating an oil and gas production site, including equipment, are called Lease Operating Costs. This could include general maintenance, environmental compliance expenses, pipeline maintenance and repair, saltwater separation or chemical treatments, labor pools, and more. These costs are often wrapped into the depletion allowance but represent a significant expense that can be capitalized and deducted over time.

Under IRS Section 199A, any losses encountered from working interest operations associated with oil and gas wells may qualify for a deduction of income of up to 20%.[3] This Qualified Business Income Deduction (QBID) leverages loss deductions against taxable income to reduce your tax payout, effectively lowering your financial risk.

As a direct participant in oil and gas exploration, development, and drilling, you become a financially vested stakeholder. As the oil well assets (specifically equipment) begin to depreciate year over year, you are eligible for a depreciation tax deduction that allows you to recover the cost of the property in question. This is typically done via the Modified Accelerated Cost Recovery System (MACRS) or the Straight-line Method.

Oil and gas tax benefits extend to other sources of active income. In most cases, you can’t apply losses from other passive income or revenue channels against your earned income from your job or company.

However, the Tax Reform Act of 1986 changed the landscape of oil and gas tax benefits by integrating direct participation or working interest investments in oil and gas, determining they’re not the same type of passive activity.[4] This classification allows for loss deductions to be offset against earned income from salaries, stocks, and the like.

Substantial tax benefits aside, the oil and gas industry is an attractive opportunity for high-net-worth investors in a multitude of ways. The high earnings potential alone is enough to ignite diversification. It is a market that has seen long-term payouts and numerous technological advancements that help to mitigate risk and liability.

As demand shifts and changes, your options for liquidity adapt with it. You can collect cash flow from the operation, sell it when you’re ready to move on, and shield the rest of your portfolio from chronic inflation and volatility.

Traditional investment paradigms are helpful but inefficient, and they lack ingenuity and collaboration. In many cases, they fail to offer the level of engagement many investors crave.

That’s where TBV rises above the rest. We’re in it with you every step of the way, investing our own funds right alongside you. This is more than an investment opportunity for us; it’s our purpose.