Hello cprushing,
And thank you for your question. I learned a lot tonight about the tax
benefits of drilling for oil.
The following deductions for drilling of an oil well were found at the
IRS web site, www.irs.gov, and when searching there for the term "oil
drilling", I found 233 hits. Some of the most pertinant information
follows:
In a publication on Intangible Drilling Costs at
http://www.irs.gov/formspubs/display/0,,i1%3D50%26genericId%3D12030,00.html:
The costs of developing oil, gas, or geothermal wells are ordinarily
capital expenses. You can usually recover them through depreciation or
depletion. However, you can choose to deduct intangible drilling costs
(IDCs) as a current business expense. These are certain drilling and
development costs for wells in the United States in which you hold an
operating or working interest. You can deduct only costs for drilling
or preparing a well for the production of oil, gas, or geothermal
steam or hot water.
You can choose to deduct only the costs of items with no salvage
value. These include wages, fuel, repairs, hauling, and supplies
related to drilling wells and preparing them for production. Your cost
for any drilling or development work done by contractors under any
form of contract is also an IDC. However, see Amounts paid to
contractor that must be capitalized, next.
You can also choose to deduct the cost of drilling bore holes to
determine the location and delineation of offshore hydrocarbon
deposits if the shaft is capable of conducting hydrocarbons to the
surface on completion. It does not matter whether there is any intent
to produce hydrocarbons.
If you do not choose to deduct your IDCs as a current business
expense, you can choose to deduct them over the 60-month period
beginning with the month they were paid or incurred.
Amounts paid to contractor that must be capitalized. Amounts paid to a
contractor must be capitalized if they are either:
Amounts properly allocable to the cost of depreciable property, or
Amounts paid only out of production or proceeds from production if
these amounts are depletable income to the recipient.
How to make the choice. You choose to deduct IDCs as a current
business expense by taking the deduction on your income tax return for
the first tax year you have eligible costs. No formal statement is
required. If you file Schedule C (Form 1040), enter these costs under
"Other expenses."
Additionally, if the well is non-productive:
If you capitalize your IDCs, you have another option if the well is
nonproductive. You can deduct the IDCs of the nonproductive well as an
ordinary loss. You must indicate and clearly state your choice on your
tax return for the year the well is completed. Once made, the choice
for oil and gas wells is binding for all later years. You can revoke
your choice for a geothermal well by filing an amended return that
does not claim the loss.
And...
You cannot deduct as a current business expense all the IDCs paid or
incurred for an oil, gas, or geothermal well located outside the
United States. However, you can choose to include the costs in the
adjusted basis of the well to figure depletion or depreciation. If you
do not make this choice, you can deduct the costs over the 10-year
period beginning with the tax year in which you paid or incurred them.
These rules do not apply to a nonproductive well.
In an IRS publication on Mineral Property at
http://www.irs.gov/formspubs/display/0,,i1%3D50%26genericId%3D12049,00.html
you find:
Mineral Property
The term "mineral property" means each separate interest you own in
each mineral deposit in each separate tract or parcel of land. You can
treat two or more separate interests as one property or as separate
properties. See section 614 of the Internal Revenue Code and the
related regulations for rules on how to treat separate mineral
interests.
Mineral property includes oil and gas wells, mines, and other natural
deposits (including geothermal deposits).
There are two ways of figuring depletion on mineral property.
Cost depletion.
Percentage depletion.
Generally, you must use the method that gives you the larger
deduction. However, unless you are an independent producer or royalty
owner, you generally cannot use percentage depletion for oil and gas
wells. See Oil and Gas Wells, later.
A complete explanation of depreciation and formulas will be found on
the above noted page.
Under Oil and Gas Wells, they state:
Generally, only independent producers and royalty owners can claim
percentage depletion for any oil or gas well. However, if you are not
an independent producer or royalty owner, you may be able to claim
percentage depletion for the following items.
Natural gas sold under a fixed contract.
Natural gas from geopressured brine.
For information on the depletion deduction for these items, see
Natural Gas Wells, later.
The page follows on with quite extensive definitons and calculations
for depletion.
Most of the additional hits at this site deal with partnerships of the
proper filling of forms. Some only use "oil drilling" as an example
for other data not related to the tax deductions of drilling. The
above are the two most specific to your question.
At Nation's Gas Production Corporation,
http://www.nationsgas.com/tax_oil&gasadv.htm, this page details tax
advantages including:
Congressional Incentives
Natural gas and oil development 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 stimulate domestic natural gas and oil production
financed by private sources. Natural gas and oil drilling projects
offer many tax advantages. These tax benefits enhance the economics of
natural gas and oil projects.
Intangible Drilling Cost Tax Deduction
Oil and gas projects are labor intensive, so a significant portion of
the expenditure is considered Intangible Drilling Cost (IDC), which is
100% deductible during the first year. For example, a participation of
$24,000 could result in approximately $15,600 in tax deductions for
IDC even if the well does not start drilling until March 31 of the
year following the contribution of capital. The remaining $8,400 of
tangible costs may be deducted as depreciation over a seven year
period. (See Section 263 of the Tax Code).
And...
Small Producers Tax Exemption
The 1990 Tax Act provided some special tax advantages for the typical
participant in oil and gas drilling projects. This tax incentive,
known as the "Percentage Depletion Allowance", is specifically
intended to encourage participation in oil and gas drilling. This tax
benefit is not available to large oil companies or taxpayers who sell
oil or natural gas through retail outlets or those who engage in
refining crude oil with runs of more than 50,000 barrels per day. It
is also not available for entities owning more than 1,000 barrels of
oil (or 6,000,000 cubic feet of gas) average daily production. The
"Small Producers Exemption" specifically allows 15% of the gross
income from an oil and gas producing property to be tax free. (See
Section 613A of the Tax Code).
As well as...
Active Vs. Passive Income
The Tax Reform Act of 1986 introduced into the Tax Code the concepts
of "Passive" income and "Active" income. The Act prohibits the
offsetting of losses from Passive activities against income from
Active businesses. The new Tax Code specifically states that a Working
Interest in an oil and gas well is not a "Passive" activity,
therefore, deductions can be offset against income from active stock
trades, business income, salaries, etc. (See Section 469(c)(3) of the
Tax Code).
The page goes on to detail Alternative Minuimum Tax and an example of
tax deductions for a smal producer.
Their Tax page, http://www.nationsgas.com/tax_irslinks.htm, also
includes links to both IRS forms and publications.
Texas Energy Investment Solutions at http://www.mroandg.com/tax.htm,
offers basically identical information to Nation's Gas and adds a
section on Section 29 Tax Credits:
Section 29 Tax Credits
Recompletions Qualify for Tax Credit in 1979, Congress enacted Section
29 of the tax code in an effort to stimulate the production of
domestic oil and gas production from nonconventional fuel sources.
The Section 29 credit was a major stimulus for drilling natural gas
wells from the late 1980s through December 31, 1992, when the tax
credit expired. IRS revenue ruling 93-54 provides that well
recompletions qualify for the credit as long as the original well
qualified for the credit and the recompletion does not involve
drilling the well deeper.
Their page also includes the caveat:
NOTE: The above is for informational purposes only. The tax
benefits, whereas commonly true to most investors in oil and gas
drilling endeavors, is not intended to be a review of all tax
circumstances. It is recommended that prospective investors consult
with their personal tax advisor with regard to specific tax matters.
Texas Energy Investment Solutions, Inc. and or its affiliations make
no offers of securities in any state pursuant to this website.
Potential investors must be aware that there are risks involved in
each offering and substantial losses are possible. Therefore, funds
to be invested must be discretionary funds of the offeree. No sale of
any securities is made in any state until such securities have been
made the subject of a duly qualified exempt transaction provision in
any state in which such security is to be sold and a final Private
Placement Memorandum is delivered to each offeree upon qualification.
It seems like a good place to also assert that I am a Google
Researcher, not an oil driller nor a tax expert, and as such, I also
make no claims other than the information I have found is public
information and directly addresses your question.
CTJ has a page at http://www.ctj.org/hid_ent/part-2/part2-8.htm,
entitled The Hidden Entitlements, where they state that "Oil and gas
companies are allowed to write off many of their capital costs
immediately, and many can take deductions for so-called "percentage
depletion"--which has no connection with actual expenses. The purpose
of these tax subsidies is to encourage domestic oil and gas
production--and apparently consumption."
They go on to say, "Normally, businesses can writeoff their
investments in plants and equipment only as those investments wear
out. Oil companies, however, can write off their so-called "intangible
drilling costs," that is, much of their investments in finding and
developing domestic oil and gas wells, immediately, even for
successful wells.18 (Major, integrated oil companies can immediately
deduct only 70%of such investments and must write off the remaining
30% over five years.)"
And perhaps most interesting on their page, "Although owners of
working interests in oil and gas properties are subject to the
alternative minimum tax, they are exempted from the "passive income"
limitations.This means that the "working interest-holder," who manages
on behalf of himself and all other owners the development of wells and
incurs all the costs of their operation, may use oil and gas
"losses"to shelter income from other sources."
Crown Petroleum, at http://www.gj.net/~cp/tax.html, has a page of tax
benefits that begins on a similar vein:
"Developing domestic reserves of oil and gas reduces the dependence of
foreign oil imports in this country. In view of this, the United
States Congress has provided to private investment sources tax
incentives to stimulate domestic production, enhancing the economics
of an oil and gas investment. Because of the passage of the Tax Reform
Act of 1986, oil and gas ventures still remain one of the few tax
advantaged investments, exempting oil and gas as Working Interest
Investment from being classified as a "Passive Income"."
And they further detail Small Producer's tax benefits where they
state: "The 1990 Tax Act provided to the investor in oil and gas
drilling projects certain tax advantages. The Small Producers
Exemption allows for 15% of any Investor's gross income from oil and
gas property to be tax free. The Percentage Depletion Allowance is
specifically intended to encourage oil and gas participation by the
investor. Large oil companies, taxpayers who sell oil or natural gas
via retail outlets or those who engage in refining more than 50,000
barrels of crude oil per day are not eligible for this tax benefit.
Nor are investors whose ownership of more than 1,000 barrels of oil or
6,000,000 cubic feet of gas average daily production eligible for this
tax benefit. Each investor's annual tax return should claim the Small
Producers Exemption. Crown Petroleum's Drilling operations will
qualify for Percentage Depletion Allowance tax Benefits."
I'll close with a small list of other pages that contain similar and
some additonal information on oil drilling tax benefits:
The Internet Oil and Gas Newsletter
http://www.mosburgoil-gas.com/html/body_stilwell_3_15_2002_2c.html
Oil-N-Gas has an interesting discussion of OGIT (oil and gas
investment trust) at
http://www.oil-n-gas.com/speech2.html
You will also find Highlights of Government Support for Energy
Investments Through the Tax System at
http://www.oag-bvg.gc.ca/domino/reports.nsf/html/c003ab_e.html
I trust this has been informative for you. As I mentioned earlier, I
am not neither an oilman nor a tax expert and there is no substitute
for counsel from a bonafide tax lawyer and/or accountant.
Good luck striking oil!
-=clouseau-ga=- |
