Energy: Oil & Gas Properties
In an effort to stimulate the U.S. economy and lessen the nation’s dependence on foreign oil, Congress has provided favorable tax incentives to encourage the development and production of domestic oil and gas properties financed by private sources. These incentives are not “loopholes” – they were placed into the Tax Code by Congress to make participation in oil and gas ventures a tax-advantaged investment for individuals and small companies.
Oil and gas investments may be made in Exploratory Drilling – drilling in an area where oil and gas fields have not yet been discovered – or in Developmental Drilling – drilling in an area where oil and gas fields are already known to exist. Rework Programs focus on refurbishing the infrastructure of existing wells and putting them back into production where quantities of oil and gas may exist.
Risks of oil and gas programs include the potential of drilling a “dry hole” or an economically unviable well. Also, the market risk—the value of oil and gas—fluctuates and is highly volatile. Note that Exploratory Drilling programs are considered “high risk,” and developmental and rework programs are considered “medium to high risk.”
Many investors are unaware that they can sell their investment real estate properties and complete a 1031 exchange into oil or gas producing wells. Generally, the IRS considers commercial real estate and producing oil or gas properties as “like kind.” You can purchase either a working interest or a royalty interest in oil or gas producing wells with your 1031 exchange funds.
Drilling programs offer many tax advantages that greatly enhance the overall economics of the investment, and make participation in oil and gas ventures one of the best tax-advantaged investment options available to high-net-worth investors. For example, for a producing well, there is possibility that up to 70% to 85% of your capital investment may constitute what are known as Intangible Drilling Costs (IDCs), which may be written off your ordinary income in the first year. In addition, tangible drilling costs (the amount of the investment allocated to equipment) may be deducted as depreciation over a five-year period.