Our constantly expanding, industrial society depends on oil and natural gas to maintain the world’s growing population and to fuel the wheels of commerce. The ever-increasing consumption of fossil fuels driven by the increased demand from the developing economies of the world, including China and India, exerts pressure on existing supplies and has continued to push prices higher for these finite resources.
Direct investments in oil and gas drilling projects allow sophisticated “accredited investors” to share in the growth of the industry resulting from the increasing worldwide demand for hydrocarbons. Oil and gas investments offer the potential of monthly cash flows, as well as tax benefits and portfolio diversification.
The domestic production of oil and natural gas provides a measure of stability against fluctuations in the global energy market by reducing our dependence on foreign imports. Since many major oil companies are moving their operations abroad in search of mega-discoveries, Congress has provided tax incentives for the oil and gas industry in order to promote energy exploration in the United States.
Each participant in an oil and gas project is entitled to certain tax deductions including intangible drilling costs, depreciation, operating costs and depletion allowance. An Investor may be able to offset his/her taxable income from other sources with the substantial deductions available from investing in oil and gas wells.
The information provided below is not intended to be an all-encompassing explanation of the tax implications generated from all oil and gas investments. Tax considerations related to an investment in an oil and gas program vary with individual circumstances. Any prospective investor should obtain professional guidance from his/her tax advisor in order to fully evaluate the tax risks associated with oil and gas investments
Cost depletion and Percentage depletion are the two methods by which an Investor may recover the capitalization cost of the oil and gas property after a well is placed into production. The taxpayer may take a deduction for the greater of the two methods.
Cost depletion is computed on the basis of initial capitalization costs. A portion of these costs can be recovered each year based on the percentage of the production volume for the year compared to the total estimated recoverable oil and gas reserves at the beginning of the year.
Percentage depletion is computed on the basis of the income from the property and is equal to 15% of the gross revenue from a producing oil and gas property. The tax shelter created by the percentage depletion allowance continues for as long as the well produces hydrocarbons.
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