Investing in oil and gas as a new and alternative tax strategy can be a great way to substantially reduce your tax burden*. But chances are, your CPA hasn’t mentioned it. That’s because, like doctors, CPAs specialize. And the same way an ENT doctor wouldn’t advise you on how to treat, say, a rash, a CPA who doesn’t live in one of the few states where oil and gas is a major commodity isn’t likely to advise a client on its advantages. It just isn’t in their wheelhouse.
But it may be worth bringing up the next time you meet. Thanks to the considerable tax write-offs available for intangible drilling costs (IDCs) and tangible drilling costs (TDCs), oil and gas investing can drastically lower your tax bill — even when compared to investing in the more traditional stock or real estate markets.
How’s that? First, let’s tackle the terminology. Then let’s take a look at the tax deductions offered in stock and real estate investment markets and do the math.
The ABCs of IDCs and TDCs.
IDCs are any costs associated with oil and gas production that cannot be resold (or recovered) later. These include drilling rig rentals, cement, consultants, casing pipe, stimulating, fracking, acidizing, mud logs, geologists and the like.
On the other side of the coin, TDCs are any asset or capital expenditure that can be recovered later. Line heaters, leasehold interests, separators, tanks and wellheads are all examples of TDCs.
Stock and Real Estate — What Most CPAs Have Heard of.
Stock investing tax deductions are limited to losses and payments for education and/or advisory services. Short-term capital gains (assets held for sale or exchange for exactly one year or less) are taxed at your ordinary income tax rate, and long-term capital gains are taxed at either 0, 15 or 20 percent. And those looking to invest in the oil and gas market wouldn’t fall into the 0 percent bracket, so it’s safe to say they’d be looking at heavy taxes with few options for relief.
Investing in real estate is more tax-friendly than the stock market, allowing investors to depreciate the cost of the property over 27.5 years on what’s called a “straight-line” basis. But the market is still not as attractive from a tax deduction standpoint when compared to oil and gas, as you’ll see demonstrated in the next section.
How Oil and Gas Tax Advantages Add Up.
Let’s say you invest in a property for $100,000. Divide that by 27.5 to get the cost depreciation allowance, and you get to deduct $3,636 per year on its investment. The only downside? To get the full tax benefit, it’ll take almost 30 years – and that’s a long time. Think about it. Thirty years ago, most people didn’t even own a cell phone.
Let’s take that same $100,000 and look at the tax consequences in an oil and gas project. An investor can deduct approximately 80 percent of this amount in IDCs. The investor can also deduct 14.29 percent for the TDCs. TDCs are depreciated according to standard IRS depreciation rules over seven years – under the same as “straight-line” depreciation as on real estate, but over a shorter period of time.
So, in the first year, an oil and gas investor can deduct $80,000 for the IDCs and $2,858 for the TDCs. This comes to a total tax deduction of $82,858 in just the first year.
To add fuel to the fire, so to speak, oil and gas investors also get a 15 percent tax-free depletion allowance of the annual production revenue. So, for example, if a project produced $86,158 in the first 12 months of production, an investor would enjoy an additional $12,924 in tax reduction benefits.
How to Bring Up Oil and Gas with Your CPA.
There are, of course, many additional factors to consider beyond tax deductions when evaluating investment strategies. And that’s why it’s important to have a candid discussion with your CPA to go over your individual portfolio and determine what investments make the most sense for you. Your CPA has the necessary expertise to discuss all of your options while taking into your tolerance for risk and other significant factors.
If you do decide to consider oil and gas as a part of your investment strategy, here’s some additional information you can forward to your tax professional that will help facilitate that discussion.
*EnergyFunders, LLC and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. It should only be used to aid tax professionals who analyze and understand their client’s individual tax circumstances. You should consult your personal tax, legal and accounting professionals before engaging in any transaction.
Casey Minshew is the Chief Operating Officer (COO) for EnergyFunders, an online marketplace evolving the way capital investment and energy projects come together. With an extensive background that encompasses 15 years of experience across technology, commercial real estate and energy, Casey brings deep knowledge and experience growing early-stage ventures into hyper-growth scalable organizations. He has been a part of three successful start-up companies, most recently growing startup iWowWe from zero to twelve million dollars in revenue in less than 2 years.