5 Tax Advantages from Oil and Gas Investments
The biggest advantage of investing in oil and gas exploration directly has always been the ability to profit directly from high energy prices. Expen
sive oil tends to mean slower economic growth; therefore, many other investments are down when oil wells are giving their biggest returns.
But as beneficial as that type of diversified investment can be, investing in oil wells still represents a very real risk – oil prices could decline, production could fall short or, worst of all, the well could come up dry.
To counterbalance that risk, the federal government has made a strong point of using tax deductions in order to incentivize investing in oil, including a number that can seriously limit the real cost of these investments.
Tangible and intangible drilling costs – Tangible drilling costs represent all the physical assets required to drill an oil well – from the rig itself to piping. Intangible costs cover just about everything else, including labor, electricity, fuel, water and any number of other expenses. Both of these categories of costs are 100 percent tax deductible, though tangible costs must be spread over a seven-year period known as the depreciation lifecycle.
Depletion Allowance – Also known as the Small Producers Tax Exemption, the federal government created a tax incentive in 1990 specifically designed to support smaller independent oil and gas companies. One of the most important incentives for direct U.S. oil investments, this policy makes 15 percent of all oil revenue earned by these smaller companies completely exempt from taxes. In order to qualify, the company cannot produce more than 1,000 barrels of oil or 6 million cubic feet of natural gas per day.
Active income – Though not entirely a tax deduction, oil income is treated as active income for tax purposes. This means that, under the 1986 Tax Reform Act, any losses or costs associated with an investment in an oil well – and therefore any related tax credits – can be used to offset other types of active income. Under those rules, tax benefits for oil income can offset anything from active stock trading to a regular salary.
Lease Costs – Like intangible drilling costs, the expense of actually leasing land and mineral exploration rights is 100 percent tax deductible in the year that the lease is paid for.
Alternative Minimum Tax – Another adjustment to the tax code from the early 1990s, Congress passed a bill in 1992 exempting oil and gas investment tax credits from the alternative minimum tax restriction. Both intangible drilling cost deductions and the depletion allowance were designated as tax preference items, including them on a short list of deductions that the federal government wanted to specifically encourage at higher income levels.
A variety of other tax advantages are available at both the federal and, in some cases, state levels, but these five alone can cut a person’s exposure from oil investments by as much as their general taxation level.
Category: Business
