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Tax Advantages of Domestic Oil & Gas Investments
In 1986, the
U.S. Congress passed the Tax Reform Act. This Act makes a direct investment
in domestic oil and gas one of the most tax-advantaged investments available
to today's investor. This act exempts oil and gas working interests from being
classified as "Passive Income" (see Section 469(c)(3) of the Tax
Code).
Other major tax
incentives available to oil and gas investors:
Intangible
Drilling Costs (IDCs):
For a producing well, 70% - 85% of your investment constitutes what are
known as IDCs and are deducted from your ordinary income in the year of
investment. IDCs include labor-intensive costs such as the drilling contractor
and professional services and are reported to the investor at the end of
the year by Pennaco.
Tangible
Drilling Costs (TDCs): For a producing well, 15% - 30% of your
investment constitutes TDCs which have been historically depreciated over
a seven-year period using the Accelerated Cost Recovery System (ACRS). TDCs
include pipe, storage tanks, and wellhead equipment. Section 179 of the
Code provides for a Modified Accelerated Cost Recovery System ("MACRS")
for the exhaustion, wear and tear of property used in a trade or business.
For those not versed in tax rules, Rule 179 (Form 4562) of the tax code
provides the business taxpayer an increased depreciation deduction for the
year in which equipment is purchased within certain limitations. Generally,
the taxpayer accelerates depreciation in the year of purchase, adjusts the
basis (cost) downward for the deduction and then used MACRS to write off
the balance. In response to the 911 attack Congress passed legislation designed
to give taxpayers immediate tax relief. One of the methods is a 30% depreciation
bonus in the year in which equipment is purchased provided the equipment
is placed in service after 9/10/2001 and before 12/31/2003. Congress also
increased the total amount allowable for Rule 179 deduction for this two
year period from $24,000 (2002) and $25,000 (2003) to $35,000 for each of
these years. In addition, the total qualifying property total increased
from $200,000 to $325,000 for the period. As written, everything returns
to "normal" for tax years beginning in 2004. Together the two
changes enable the taxpayer to deduct a little over 60% of the initial cost
of the equipment in the first year. However, under a recently passed tax
code change, a taxpayer may now deduct up to a full $100,000 of any equipment
cost in the first year.
Depletion
Allowance:
If you
are an investor in an independent oil and gas project, the current depletion
allowance is 15% of your share of the gross income from the property based
on average daily production, up to the depletable oil or natural gas quantity.
This makes fifteen cents of every gross income dollar non-taxable, therefore
producing tax-sheltered income.
Dry
Hole: In the event that you invest in a nonproducing well, 100%
of all dollars invested are written off as a loss against your ordinary
income in the first year.
Most direct investments
in drilling operations qualify for the tax benefits listed above, which are
not available to those purchasing stock in publicly-traded oil companies.
The above examples
are for general information only and not intended to be construed as individual
tax advice. Consult your personal tax advisor concerning the applicability
and effect on your personal tax situation. Tax laws change from time to time
and there can be no guarantee of the interpretation of the tax laws. Your
individual Pennaco Investment Advisor can help answer specific oil and gas
tax questions.
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