Tax Advantages of Oil and Gas Drilling
Oil and Natural gas from domestic reserves helps to make our country more energy self-sufficient by reducing our dependence on foreign imports. In light of this, Congress has provided tax incentives to encourage domestic natural gas and oil production financed by private sources. Drilling projects offer many tax advantages and these benefits greatly enhance the economics. These incentives were placed in the Tax Code by Congress to make participation in oil and gas ventures one of the best tax advantaged investments.
Intangible Drilling and Development Costs (IDC)
The cost of labor, fuel, repair, hauling, supplies, etc., incident to and necessary for the drilling and preparation of wells for the production of oil and gas, including work done by any contractors under any form of contract. IDC does not include pipe and equipment that becomes part of the well. The IDC generally runs between 70% and 90% of the total investment for oil and gas wells and are 100% deductible. However, as a Limited Partner the IDC can generally only be used to offset passive income from other ventures immediately or from passive income from this Partnership once Distributions commence. IDC costs can be carried forward for use in future tax years.
Depletion
Depletion allows the owner of a producing oil and/or gas well to recover his investment through tax deductions over the period in which oil and/or gas is produced. The rate for percentage depletion is generally 15%. The deduction in any tax year may not exceed 65% of the taxpayers' taxable income from all other sources. This tax incentive, known as the "Percentage Depletion Allowance" is specifically intended to encourage the smaller investor to participate in oil and gas drilling, and is only for investors owning not more than 1,000 barrels of oil or 6,000,000 cubic feet of gas, average daily production. Each Partner should state in their individual tax return that they claim the "Small Producers Exemption". (See Section 613 (A) of the Unified Tax Code.)
The impact of these tax benefits is to shield oil and gas income from taxes to encourage investment, in the case of the IDC to lower the after-tax cost of the initial investment and in the case of the depletion allowance to reduce the on-going tax expense to encourage the oil and gas investor to re-invest to maintain production of this depleting asset.
