Oil and gas investments not only present a lucrative opportunity for accredited investors to yield high returns, they also entail a number of tax breaks that make the proposition even more enticing. While most investors have a fair idea about how things work on the investment side, things on the tax front are often clouded with various doubts. To help clear the air, in this article, we highlight all the tax breaks associated with oil and gas investments, which are found nowhere else in the tax code. Take a look.
Intangible Drilling Costs
The tax code defines “intangible drilling costs” as all costs incurred on the items necessary for drilling, including labor, chemicals, mud, grease, and other miscellaneous expenses. This, however, does not include the cost of the drilling equipment. Tangible drilling costs are 100 percent deductible in the year they are incurred.
Tangible Drilling Costs
Tangible drilling costs basically pertain to the actual cost of the drilling equipment used in a project. Just like intangible drilling costs, tangible drilling costs too are 100 percent deductible, but there is a difference. Unlike intangible drilling costs that are deductible in the same year, the tangible drilling costs are to be depreciated over a period of 7 years.
Active vs Passive Income
The tax code does not consider a working interest in an oil and gas project as a passive activity, which implies that all net losses incurred in a project are to be considered as active income that is incurred in conjunction with well-head production. This cost, therefore, can be offset against other streams of income such as wages, capital gains and interest.
Small Producer Exemption
Also called “depletion allowance”, the small producer exemption is probably the most enticing tax break for qualified producers and investors. This incentive exempts 15 percent of the gross income made from qualified oil and gas projects. However, as the name suggests, this incentive is offered only to small producers and their investors.
Alternative Minimum Tax
The alternative minimum tax (AMT) return exempts all additional intangible drilling costs, by regarding them as a “preference item.” The AMT was established to place a baseline tax to ensure that a taxpayer pays a minimum “fair share” of taxes to the government. The AMT recalculates the income tax to be paid by a taxpayer after adding certain preferential tax deductions or items.
In simple words, lease costs include all the expenses incurred during the negotiation and procurement of the lease and mineral rights, including lease operating costs, and other administrative, legal and accounting expenses. All lease costs are exempt and deducted over the course of the lease agreement through the depletion allowance.
Oil and gas investments, besides promising high, long-term returns, entail a number of tax benefits that make the avenue all the more worthwhile for qualified investors. Having said that, with an increasing number of oil and gas projects in Texas and other parts of the US, finding the most rewarding can be a challenging endeavour. That is when you can count on the expertise of the oil and gas investment consultants at Main Oak Capital. To learn more about our capabilities and ongoing oil and gas investment projects, talk to us at (972) 544-1645 or send an email at firstname.lastname@example.org. You can also fill out our contact form and we’ll take it from there.