Oil & Gas Investing

Investing in Oil Wells: A Lucrative Strategy

Investing in oil wells is a lucrative strategy for avoiding the stock market and often yields significant tax benefits.

Oil makes the world go around, and that is certainly not going to change any time soon, because there is still a high demand for oil.

Similarly, natural gas is a good source of cooking and heating energy. It can also be converted into electricity and diesel fuel. It is also vital in the manufacture of chemical fertilizers.

While the price of oil has increased over time, the demand for natural gas in the United States has been low since 2012, meaning this could be the best time to buy natural gas and sell when demand increases or supply decreases.

Investing in oil wells has its benefits, but you must first understand the risks involved.

What Does This Mean?

A direct oil well investment is also known as a direct participation program.

This program is divided into two categories: working interest ownership and limited partnership ownership.

Working Interest Ownership

This is a standard investment channel that was used in the early 1920s for oil drilling programs. In this channel, you own a piece of the oil well, and your obligations are higher than in a limited partnership.

Limited Partnership Ownership

Oil and gas partnerships started in the early 70s. The difference between working interest ownership and limited partnership is that the latter incorporates working capital to give more power to the general partners. Management fees and revenue sharing are calculated once payouts are done.

Tax Benefits of Oil and Gas Investing

• Intangible Drilling Costs: 80% of investments made are considered intangible drilling costs and can be subtracted from the money you earn. Examples include grease, mud, chemicals, and labor. These costs normally take between 60 to 80 percent of the total cost of oil drilling. For instance, if drilling a well costs $150,000 and 75 percent of the cost is considered intangible, investors would get a deduction of $112,500. These costs are deducted yearly. Moreover, it does not matter if the well strikes or produces any oil; deductions are made as soon as drilling commences. Intangible drilling costs are regarded as “tax preference items,” hence they are exempted when considering the 1992 Tax Act, Alternative Minimum Tax.

• Tangible Drilling Costs: 20% of investments made are considered tangible drilling costs. Tangible costs are directly related to the value of drilling equipment. These costs are also deducted per annum. They can be subtracted if incurred in the first year. 100% of these expenses are subtracted in the year of investment. Companies, through the IRS tax code, Section 179, can subtract the purchase price of equipment bought or funded in the tax year.

• Depletion Deduction: There is also a “depletion deduction” which allows 10 percent of oil and gas gross income to be tax-free.