Tangible And Intangible Drilling Cost Deductions

Tangible And Intangible Drilling Cost Deductions

July 21, 2020

There are many tax advantages available for investors who are sophisticated and wealthy enough to move beyond the most common asset classes. The greatest advantages, perhaps, can be found in the oil and gas industry. The U.S. government wants to build our domestic energy production and one of their methods for doing so is by offering impressive tax benefits for investors who get involved. Two of the major tax benefits come from tangible drilling costs and intangible drilling costs.

Tangible Drilling Costs

Tangible drilling costs are the actual direct costs of drilling equipment, such as rigs and machinery. When drilling a new well, about 30% of the drilling costs are tangible. These costs are 100% tax-deductible but must be depreciated over 7 years. 

Intangible Drilling Costs

The other 70% of drilling costs are classified as intangible. Intangible costs are expenses that cannot be recovered but are necessary for the drilling and preparation of wells for production. These costs include survey work, drainage, ground clearing, fuel, wages, repairs, hauling, and supplies; basically everything except the actual drilling equipment and leases.  

Intangible drilling costs are 100% tax-deductible in the year incurred. It doesn’t matter if the well produces or strikes oil; as long as it is operating by March 31 of the following year, the intangible costs are 100% deductible. In addition, investors are also able to amortize all or a portion of the costs over a 5-year time period instead of taking the entire deduction in the first year.

IRS rules allow investors to receive a substantial ordinary income tax deduction related to intangible drilling costs. These deductions can be used to offset ordinary income or capital gains for those who invest as general partners. Limited partners can use them to offset passive income. 

Intangible drilling costs are an above-the-line deduction on the federal Form 1040. That means that they reduce adjusted gross income and also taxable income. As such, taxes due are reduced as well and most states also allow for the deduction. In addition to reducing total taxes due, intangible drilling cost deductions can also lower the tax bracket to which an investor is subject. 

The tax benefits of investing in oil and gas are clear and convincing. U.S. Energy Development Corporation even provides an online calculator that can be used to estimate the tax benefits of various investments based on pre-investment taxable income and state tax rates. For example, an investor with a regular income of $500,000 that invests $250,000 and takes the intangible drilling cost deduction all in the first year can save over $77,000 on federal taxes, which is 31% of the original investment. If the marginal state tax rate is 8%, then there is an additional $20,000 state tax savings, for a total of 39% of the original investment. 

How We Can Help

While lucrative, oil and gas investing is not for everyone. It is a riskier investment that should only be made as a part of a strategically designed overall investment portfolio. At Haydel, Biel & Associates, we assist investors like yourself in constructing investment portfolios that take advantage of available tax benefits while taking a balanced approach to achieving your goals. If you want to learn more about the benefits of oil and gas investments and how they may fit into your investment portfolio, contact us at (626) 529-8347 or email Ricky directly at ricky@hbawealth.com.

About Haydel, Biel & Associates

Haydel, Biel & Associates is an independent financial advisory firm serving individuals and families near Pasadena, California. The firm was founded in 2004 by Chris Haydel and Ricky Biel with a desire to provide unbiased, client-centered, community-based financial advice. Together, they have built a practice that has grown into a family of caring, smart professionals committed to blending proven investment methodologies with creative financial technologies that make it easier than ever to accomplish your goals. They strive to keep things simple and fun to give their clients peace of mind and alleviate financial stress. HBA Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the HBA Wealth team may be able to help, contact them today at (626) 529-8347 or email Ricky directly at ricky@hbawealth.com.

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