Becoming tax savvy isn’t a goal for most people. Still, tax breaks are one of the most important ways to keep the wealth you earn.
The United States is quickly becoming a leading supplier of the world’s oil and gas. More than 20 million barrels of oil per day came from the U.S. in 2018.
Oil and gas tax breaks are now seen as one of the most advantageous of all investment tax incentives. When planning your investment portfolio, give oil and gas a try.
With the United States government helping to minimize your risk, there are few cons to an oil drilling investment. Check out this overview of why investing in oil is the right move.
Well Investment: A Patriotic Opportunity
The success of the oil and gas industry is in many ways a matter of national security. Domestic production of oil and gas allows the United States to depend less on foreign oil which sometimes has strings attached.
Oil drilling investments in the United States are an opportunity to get better oil and gas resources in our own backyards. The United States consumes more imported oil than any other country puts it in a vulnerable position.
When negotiations go badly with countries that might not agree with the political values of the United States, Americans run the risk of limited or unaffordable resources. Enter independent American oil wells.
These oil wells offer the U.S. a chance to compete with foreign oil and protect our ability to maintain our values. According to the Washington Post, even as tensions between the U.S. and the Middle East are high in 2019, the development of independent oil helped us avoid an energy crisis.
The goal with oil investment isn’t to completely stop trading foreign oil, however. Foreign oil is extremely important in keeping a balanced world economy.
The United States government wants to encourage production and investment in oil and gas. When the domestic production of oil and gas becomes stable, the country has a backup in the event of a major political dispute.
Oil and gas tax breaks are the government’s way of making sure investors and producers get rewards for boosting the nation’s economy. These tax breaks help reduce barriers to long term investment in oil.
Oil and Gas Tax Breaks
Investing in oil and gas comes with a variety of tax incentives that help stretch profits. Consider how the following investment benefits can help your bottom line:
1. Tangible Drilling Deductions
Any drilling equipment and physical items with resale value fall into the category of tangible drilling costs. These costs make up a major expense for oil and gas producers.
This deduction can’t be taken all at once, however. Tangible drilling costs must be deducted over the course of seven years.
Investors benefit from a 100 percent deduction on any tangible drilling costs.
2. Intangible Drilling Deductions
Intangible costs are high for oil and gas investors. In some cases, intangible expenses make up 80 percent of your overall budget.
Basically, anything that isn’t a tangible cost is an intangible cost. The cost of hiring employees, filing paperwork, and land surveys are all examples of intangible drilling costs.
These types of expenses are deductible within the first year they are incurred. The only catch is that the oil well has to be operational by March 31st of the following year.
Between tangible and intangible drilling expenses, most investors deduct all of the costs associated with oil and gas production. Few other investments can boast the same return.
These oil and gas tax breaks apply even when the rig doesn’t produce any oil. If the project performs poorly, your deduction is protected.
3. Cost Deductions for Lease
Use a depletion allowance to write off the cost to lease oil and mineral rights on property. The deductions must be written off over the term of the lease and capitalized.
An example of a lease deduction might be accounting expenses or other administrative jobs needed to get and maintain the oil and mineral rights.
4. Depletion Allowances for Small Producers
Small producers can avoid taxation on 15 percent of gross income. To qualify as a small producer, you have to produce fewer than 50,000 barrels of oil per day.
If you produce more than 50,000, you can still claim the depletion allowance if you own less than 1,000 barrels. The purpose of the deduction is to account for the depletion of natural resources of a site over time.
The amount of oil that can be produced is finite, which allows investors to balance out future losses through partial tax exemption.
5. Alternative Minimum Tax
Investors can also claim 100 percent of excess intangible development and drilling costs exempted as a tax preference item. This deduction is taken on an alternative minimum tax return.
6. Net Losses
Any net losses that are incurred in the production of a well-head can be deducted at 100 percent. These losses are helpful in offsetting wages and capital gains in other investments.
The U.S. government doesn’t discriminate when it comes to oil and gas tax breaks for wealthy investors. No matter whether your net worth is one billion dollars or one hundred thousand, you can still claim available deductions.
The only income or wealth rule for oil and gas tax breaks comes with the limitation of 1,000 barrels per day if you plan to claim small producer deductions.
Ways to Invest
Green energy has its place, but the oil and gas industry still earns hundreds of billions of dollars each year. The industry focuses on three main areas of oil and gas production:
Upstream production is all about exploration and finding natural gas fields. It’s the first phase of oil and gas production and the one where drilling occurs. Midstream involves logistics like building pipelines and transporting oil using trucks or tankers.
Downstream is the filtering of raw materials and distributing oil products like gas. Downstream can also include marketing and other administrative services.
Oil and gas investors have four main options when it comes to getting started in a venture. There are both active and passive avenues with drastically different levels of risk and tax benefits.
One common way to invest in oil and gas is through a partnership. Investors often choose a limited partnership because their liability is limited to the amount they invest in the venture.
There’s flexibility in how each investor can participate in tax incentives with a limited partnership. They can either file as a limited partner where deductions are subject to passive loss rules or classify themselves a general partner where ordinary income can be deducted.
In either case, the oil and gas tax breaks are available on a pass through basis. Limited and general partners receive a K-1 statement every year that details his or her share of the expenses and income.
2. Working Interests
Want to be hands on with your oil and gas investment? This form of investing includes the highest risk and most involvement.
All income you receive in this strategy needs to be reported on your Schedule C as a form of self-employment. Self employment income is subject to self employment tax.
The major disadvantage to this level of involvement is that you have unlimited liability.
It’s possible to just invest in the oil and mineral rights on the land where the oil rig is set up. When you own these rights, oil producers must pay you royalties.
These royalties range in percentage of gross production. The typical range is 12 to 25 percent.
The major advantage to receiving royalties is having no liability for the business venture. On the other hand, you can only use the depletion allowance for tax breaks. No other deductions are allowed.
4. Mutual Funds
The most passive style of oil and gas investing is through mutual funds. This option is least helpful when it comes to tax breaks.
With mutual funds, investors are required to pay tax on dividends and capital gains just like with other investments. The upside is that investors assume no risk or liability related to the oil and gas venture.
The Bottom Line
Oil and gas tax breaks help those who help the U.S. economy. If you’re an accredited investor, oil and gas is a viable way to strengthen your portfolio.
Being accredited means you meet the minimum income and net worth requirements set forth by the SEC. With our dependence on oil and gas continuing to increase, the opportunities to participate in profits has never been higher.
Clean energy technology means more and more sustainable ways to produce oil that fuels the economy for years to come. Consult with an oil and gas expert today to learn how you can partner with us to upgrade your investment strategies.