If you are a sophisticated investor looking for investment opportunities, Weatherby Energy suggests looking into gas and oil production. One of the great benefits to investing in gas and oil is that there are a number of tax incentives for doing so. The US dependence on foreign sources for gas and oil has long been an issue. In an effort to help spur domestic exploration and production, the US government has created these tax benefits that are like no other in the tax code. Whether you are a small producer like Weatherby Energy or an investor, you can take advantage of these incentives. If you are considering investing in gas and oil, Weatherby Energy advises that you thoroughly examine these tax incentives so that your portfolio can take full advantage of them.
Weatherby Energy recommends that you become familiar with several terms if you are going to invest in oil and gas. It is not unusual for tax incentives to change periodically, so be sure to stay up-to-date on any changes and how they may affect your investment. Another thing to keep in mind is that these are not tax loopholes that people have found a way to exploit. These incentives have specifically been enacted into the tax code. Some of the terms are:
Intangible Drilling Costs (IDC): Essentially, these costs cover everything except the equipment that is actually used for drilling. Some of the items that are considered intangible are labor, mud, grease, chemicals and a variety of miscellaneous expenses. These costs comprise the bulk of the total expenses, and can be anywhere from 65% to 80% of the cost to drill a well. Weatherby Energy has found that one of the greatest tax benefits available is related to IDCs. IDCs are 100% tax deductible in the year that they are incurred, regardless of whether or not the well actually produces and oil or gas in that year. Suppose the total costs to drill a new well were $250,000. Let’s assume that the intangible costs were determined to be 75% of this. That means that the investor could take a deduction of $187,500 for that year.
Lease Costs: Like IDCs, these expenses are 100% deductible for the tax year in which they occur. These costs can include the cost to purchase lease and mineral rights, operating costs of the lease, and all expenses related to legal, administrative and accounting activities.
Tangible Drilling Costs (TDC): These costs refer directly to the drilling equipment’s actual cost. Like IDCs, TDCs are 100% deductible, but they have to be depreciated over a 7 year period rather than taken in one year. If we use the example above, that means over a 7-year period the remaining $62,500 investment could be written off.
Active & Passive Income: The IRS treats Gains and losses through passive and active activities differently. Since a working interest in a gas and oil well is considered to be an active activity, any losses can be offset against other active activities such as salaries, wages, tips and capital gains.
Alternative Minimum Tax (AMT): Not everyone is subject to the Alternative Minimum Tax, but if you are, excess IDCs have been given a specific exemption as a “preference item”.
Small Producer Tax Exemptions: This is one of the best tax incentives, according to Weatherby Energy, and is only available to investors and small companies. (“Small” is a specific determination based on how much oil they produce or own.) This benefit is commonly referred to as a “depletion allowance”. 15% of the gross income from gas and oil wells gets excluded from taxation.