Oil & Gas
Taxpayers can invest in oil and gas companies as a way to take advantage of multiple tax benefits
Commonly referred to as Section 263 and intangible drilling costs tax
Do I Qualify for the Oil & Gas?
Investing in oil and gas companies can provide many tax benefits, including tax deductions, depreciation and depletion allowance.
2022 Oil & Gas Details
The benefits of investing in oil and gas companies are similar to those of investing in real estate, with the added benefit of special accelerated depreciation for well drilling costs.
To take advantage of this strategy, taxpayers invest directly in private oil and gas drilling operations as opposed to investing in stocks. This direct involvement means the investor assumes a direct liability for the costs of drilling, exploration and production associated with the oil or gas wells. Generally, the investor will be a general partner in the organization.
Because of the direct liability for costs, the investor has what is called a “working interest” in the oil and gas production. This working interest means that the investment is not considered a passive activity and the investor may use losses to offset income. These are qualified business losses that might offset any qualified business income deduction allowed under 199A.
IRS Section 263 Intangible Drilling Costs Tax Treatment:
• What are intangible drilling costs? IDCs are for the costs of labor, services and non-salvageable materials. Think of them as items that can’t be resold in any way later. They typically account for 65%–85% of the total investment.
• Are intangible drilling costs deductible? Yes. An investor can deduct 100% of the investment that is allocated to intangible drilling costs (IDCs). They can be deducted within the first year of investment.
Depreciation of Oil and Gas Assets: The remaining tangible items, such as equipment, are allowed to be depreciated over seven years. Currently, bonus depreciation is allowed for 100% for lease and well equipment.
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Benefits
• Working interest in oil and gas is not a passive activity, so it can offset active income. Loss of investment is deductible.
Considerations
• Wells could underperform, fail entirely or, worse, create liability
• May create additional reporting burdens
• Initial buy-in is very high because of production costs
Assumptions When Taking the Oil & Gas
• The taxpayer is investing in a "working interest," not an oil and gas royalty, nor just in stock in an oil and gas company.
• The IDC percentages reported by the oil and gas company are accurate and not overstated.
Conflicting Strategies
• None noted.
Requirements to Claim the Oil & Gas
• The taxpayer must invest in a direct working interest in a well and assume unlimited liability in the investment.
• The wells must be in the US.
• Drilling of the well must start within 90 days after the close of the tax year.
Business Entities That Can Claim the Oil & Gas
• Individual
The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.