Why Invest In Oil?
Publicly Traded Oil Company Stock vs. Direct Participation Oil Investments
Direct participation programs in oil and gas investing offer a significant difference from investing in stocks with major oil companies. One key distinction is that direct participation programs allow investors to share directly in the profits from oil production. This means that investors have the potential to earn a portion of the revenue generated by the production and sale of oil and gas.
In contrast, investing in stocks with major oil companies typically involves purchasing shares of the company's stock, which does not directly entitle the investor to a share of the profits from oil production. Instead, investors in oil company stocks rely on the company's overall financial performance and stock price appreciation for potential returns.
Direct participation programs provide a more direct way for investors to benefit from the profitability of oil and gas projects. This can be particularly advantageous in times of high oil prices, as investors have the potential to earn substantial returns through their direct participation.
Furthermore, direct participation programs may also offer tax advantages to investors. These programs often allow investors to offset any losses incurred against other forms of income, such as interests, capital gains, and wages. This can provide additional benefits and potential tax savings for investors.
Overall, investing in oil and gas projects through direct participation programs provides investors with the opportunity to directly share in the profits of oil production, potentially leading to higher returns and tax advantages compared to investing in stocks with major oil companies.
Tax Advantages
The oil and gas industry benefits greatly from the advantageous provisions in the U.S. tax code. In 1986, the Federal Government introduced special tax deductions for investors who directly finance oil and gas wells. A recently enacted law allows investors to deduct the entire well cost in the first year of investment, from 2018 to 2023.
For more than thirty years, affluent individuals have utilized these deductions to decrease their taxable earnings. Instead of paying taxes to the government, they have allocated that money towards drilling oil and gas wells. The tax code also provides the opportunity to safeguard the future income generated from those wells. Consequently, this results in lower tax payments at present, along with the potential for numerous years of tax-favored income sources in the future.
Intangible Drilling Costs Tax Deduction
The non-recoverable expenses of an oil and gas well are known as “intangible drilling costs” (IDCs). These include things that you can’t resell later including fuel, drilling fluids, and wages. IDCs typically make up roughly 65 – 80% of the well cost, and you can deduct
100% of IDCs in year one of the project.
For example, if you make a $100,000 investment into a drilling program with 75% IDCs, you reduce your taxable income by $75,000. You also get a little leeway with the timing. IDC deductions become available in the year the money gets invested, even if the well does not start drilling until March 31 of the following year. (See Section 263 of the tax code.)
Tangible Drilling Costs Deductions
Tangible drilling costs (TDCs) refer to the well costs that you can potentially recover, including wellheads, tanks, leaseholds, etc. TDCs typically make up between 20 – 35% of drilling expenses, and they are also 100% tax deductible.
In the past, tax rules forced investors to take TDC deductions over a seven-year depreciation schedule. But thanks to a new 2018 law in effect until 2023, you can now deduct 100% of the TDCs in the first year. So instead of having to apply these tax savings over seven years, you can now bring forward 100% of your TDC deductions into the current tax year.
The end result for investors is that, through at least 2023, you can now deduct up to 100% of the upfront cost of drilling a well from your current year taxes. But that’s not all – as an individual investor, you can enjoy even greater tax benefits after drilling the well when the production
Depletion Allowance
The 1990 Tax Act allows energy producers under a certain volume limit to exempt 15% of their gross income from federal taxes. The incentive is designed to support independent energy
producers and individual investors.
Here’s how it works...
The Depletion Allowance applies to small companies that produce no more than 50,000 barrels per day of oil. As an individual investor, you qualify for the Depletion Allowance if your share of production falls under a threshold of 1,000 barrels of oil per day or 6,000 cubic feet of gas per day.
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