The Independent ProducerAmerica’s determination to increase domestic reserves and be free of OPEC dependency has placed a tremendous need for capital on oil and gas companies. The burden is particularly heavy for independent producers whose funds are more limited than those of major oil and gas companies which fund their drilling activities with the sale of stock. Most Independent Operators, which drill the majority of the Nation’s wells, are able to provide investors with cash flow and tax advantages through direct participation in oil and gas programs, thus avoiding the major oil companies’ corporate overhead.Oil and Gas Investing Tax Treatment
The Tax Reform Act (Act), enacted in 1986, made significant changes to the tax laws as they pertain to oil and gas investments. The Act attempted, for the most part, to shift more of the tax burden from individuals to corporations. The Act affected the ability of taxpayers to shelter income.Intangible Developmental Costs
The Act allows Domestic Intangible Development costs to be expensed or capitalized at the discretion of the taxpayer. Furthermore, intangible costs may be deducted by the taxpayer in the year the well is drilled.Tangible Developmental Costs
Currently, the drilling of an oil and/or gas well is considered production of an asset. The tangible well costs are capitalized and amortized over a seven (7) year period, beginning with the month in which they are paid.Depletion
Independent producers and royalty owners can claim percentage depletion of 15% on domestic production. Depletion costs may be recovered using whichever of two (2) methods provides a higher deduction, cost depletion or percentage depletion.Percentage depletion for oil and gas properties is limited to independent producers and royalty owners for daily production up to 1,000 barrels of crude oil or an equivalent amount of natural gas. However, percentage depletion cannot exceed 65% of overall income.
Breakdown of Deductions*
Expensed year incurred
Depreciated over 7 years
Depreciated over life of well
Organization & Due Diligence
Amortized over 60 months
Amortized over60 months
Investing in Oil and Gas Can Be Rewarding
Although there is principal risk associated with investing in oil and gas programs, there are substantial benefits. In addition to the aforementioned tax benefits, informed and selective investors have the potential to recover their initial investment and continue to receive cash distributions.