Certain tax benefits may be available to those investing in an oil and gas partnership. The following is for general information only and should not be relied upon without consulting your tax advisor. For more information visit www.irs.gov
- INTANGIBLE DRILLING COST (IDC) DEDUCTION:
Many, if not most, of the expenses incurred to drill, test, and complete an oil or gas well are deductible for federal income tax purposes. The deduction includes expenditures for drilling rig rental, wages, fuel, supplies, repairs and many other costs incurred for non-salvageable equipment and services necessary for drilling a well and preparing it for production. At the election of the partner, intangible drilling costs can either be deducted in the year they are paid or amortized over sixty months. IRC Sections 263(c), 59(e), and Treasury Regulation Sections 1.612-4 and 1.612-5.
- DEPRECIATION DEDUCTION:
The costs of most salvageable equipment placed in service by a partnership will be recovered through depreciation deductions over a seven-year period. Accelerated methods are used until the straight line method would generate a larger amount at which time the partnership switches. IRC Section 168(b) and (c).
- PERCENTAGE DEPLETION DEDUCTION:
For independent producers, such as individual investors in an oil and gas partnership, the Internal Revenue Code provides a percentage deduction for depletion. This percentage depletion deduction is in addition to the deduction for cost depletion available to all producers. Subject to certain limitations, the percentage deduction is generally 15% of the gross income produced by the oil and gas well. Additionally, in the case of marginal producing oil and gas wells and based upon a reference price of oil and gas provided by the IRS, the deduction can be as high as 25% of gross well income. IRC Sections 611, 613, 613A(c)(6).
- GEOLOGICAL & GEOPHYSICAL DEDUCTION:
Historically, certain costs incurred for geological or geophysical analysis were not deductible. After recent legislation, these costs are now deductible over a 24-month period. IRC Section 167(h).
- ALTERNATIVE MINIMUM TAX:
For independent producers, such as investors in an oil and gas partnership, the Internal Revenue Code allows each partnership to deduct their share of each well’s intangible drilling cost (IDC) and depletion deductions to reduce the partner’s alternative minimum taxable income (AMTI). Under current law, so-called “excess intangible drilling costs” may not reduce AMTI by more than 40%. Nevertheless, an investment in an oil and gas partnership can reduce a partner’s AMT liability. IRC Section 57(a)(2)(E).
- PASSIVE ACTIVITY EXCEPTION:
The Internal Revenue Code does not include a working interest in any oil or gas property under the definition of passive activity as long as the general partner holds the property outside of any entity under which state law limits the taxpayer’s liability. IRC Section 469(c)(3)(A). Because the general partner is allowed to treat the initial losses as non-passive, any income generated by the well is also treated as non-passive. IRC Section 469(c)(3)(B).
- SPECIAL RULE FOR TIMING OF CERTAIN DEDUCTIONS:
Amounts paid during the current year for drilling an oil or gas well are deductible in the current year if paid on or before December 31 and if drilling operations commence before the close of the 90th day after the close of the partnership’s tax year. IRC Section 461(i)(2)(A).
- MARGINAL WELL PRODUCTION CREDITS:
If the published IRS reference price for natural gas is less than $2 per mcf (1,000 cubic feet) or less than $18 per barrel for oil, a tax credit of up to 50¢ per mcf or up to $3 per barrel of domestic oil production may be available to an independent producer. IRC Sections 38 and 45I.