The Tax Benefits of Direct Participation Oil and Gas Investments
The U.S. government offers significant incentives to encourage investment in domestic oil and gas projects. With more producing oil and gas wells in the U.S. comes the country’s ability to become less dependent on foreign oil. As a way to stimulate more private-source drilling and production, the U.S. government offers tremendous tax incentives to those who participate directly in oil and gas ventures. These incentives are legitimate tax breaks documented in the U.S. Tax Code. The first, and possibly most significant, tax deduction we’ll cover here is the Intangible Drilling Cost Tax Deduction.
INTANGIBLE DRILLING COST TAX DEDUCTION
Intangible costs of drilling oil and gas wells typically account for upwards of 85% of the total cost of completing a well. These intangible costs include line items such as labor, chemicals, water costs, etc. These intangible drilling costs (IDCs) are 100% deductible during the first year.
To put this in perspective, imagine this simplified example:
You decide to invest $100,000 into a direct participation oil and gas project. This investment would provide up to $85,000 of tax deductions in the first year, assuming IDCs equaled 85% of the total cost of drilling the well. Also note that these deductions can be realized in the year you invested your money, even if actual drilling doesn’t begin until the following year (must be started by March 31st).
For a much more detailed explanation of intangible drilling cost tax deduction, please refer to the Tax Code, Section 263 or consult a qualified CPA.
TANGIBLE DRILLING COST TAX DEDUCTIONS
In the simplified example we gave for intangible drilling costs, up to $85,000 was 100% tax deductible. In that example, with the total investment equaling $100,000, there is $15,000 we didn’t discuss. That $15,000 represents the amount that went toward acquiring the necessary equipment. Equipment costs represent what the IRS calls “Tangible Drilling Costs” or TDCs. These TDCs are also 100% tax deductible and may be depreciated over a 7-year timeframe.
Again, this is a simplified example to explain the tremendous tax benefits available. For a much more detailed explanation of these tax deductions, please refer to the Tax Code, Section 263 or consult a qualified CPA.
LET’S TALK IRAS, 401KS AND SEPS
DPPs are “qualified” for your IRA, 401k and SEP, which means you can use self-directed retirement plan funds into DPPs by way of transfer/rollover without facing any penalties or taxation. Just remember, most self-directed retirement plans include tax-deferred contributions and growth, so approved taxes that typically apply when making cash contributions will likely not apply. However, if you withdraw cash from a retirement plan (signalling a taxable event) and then invest the amount you withdrew into a DDP, you could likely qualify for tax write-offs. Please consult your financial advisor, money manager or retirement specialist for the specifics that apply to your situation and your financial goals.
ACTIVE VS. PASSIVE INCOME
Another tax benefit of investing in oil and gas direct participation programs exists in the current tax code, which states that having a working interest in oil and gas wells if not considered a passive income activity. Because having working interest in oil and gas wells is considered an active income activity, all net losses are active income that relate to well-head production and therefore can be offset against other forms of income.
*The tax explanations mentioned here are based on how we understand the rules of the SEC. For direct information, please consult a qualified tax consultant or visit
Source: Homebound Resources, LLC