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The following general discussion is provided for background
information only. Potential investors should consult with
their own advisors.
CONGRESSIONAL INCENTIVES: Oil and gas development
from domestic reserves help to make our country more energy
self-sufficient by reducing our dependence on foreign imports.
In light of this, congress has provided tax incentives to
stimulate domestic production financed by private investment
sources. These tax benefits enhance the economics of an
oil or gas investment. With the passage of the Tax Reform
Act of 1986, oil and gas ventures are now one of the most
tax advantaged investments. The Act specifically exempts
oil and gas working interests from being classified as "Passive
Income". (See Section 469 (c) (3) of the Tax Code.)
INTANGIBLE DRILLING COST TAX DEDUCTION: Intangible
drilling and development costs (IDC) are 100% deductible
in the year that they are incurred or paid. These are expenditures
for items that have no salvage value, and are "incidental
to and necessary for the drilling and the preparation of
wells for the production of oil and gas". They include such
costs as wages, rental equipment, surveying, building roads,
preparation of well location, transporting the rig and equipment
to the drill site, drilling, consumable supplies such as
water, fuel, mud, drill bits, cementing, logging, coring,
drill stem testing, installation and perforation of casing
(but not the casing itself), fracturing, acidizing, swabbing
and installation of production equipment (through the christmas
tree). Intangible drilling costs usually average between
60% to 85% of the capital invested in a drilling venture.
(See Section 263 of the Code.)
DEPRECIATION OF TANGIBLE EQUIPMENT: Equipment costs
are amortizable expenditures for tangible assets that have
a future useful life and have a salvage value. Well equipment
costs include such items as casing, tubing, rods, various
equipment placed in the borehole in connection with running
and cementing casing, pumping equipment, flow lines, separators,
treating equipment, tank batteries, and salt water disposal
equipment. As with equipment costs in any other business
or industry, lease and well equipment costs can be depreciated
and deducted from gross income through annual depreciation.
Most equipment will be depreciated over a five to seven
year period.
SMALL PRODUCERS TAX EXEMPTION: This benefit is also
known as the "Small Producers Exemption", since it is not
allowed to those individuals owning production of more than
1,000 barrels of oil or 6,000 MCF of gas per day. Mineral
deposits under a leased property are natural resources referred
to as a "wasting" capital asset, and the exhaustion of these
resources through extraction is called physical depletion.
The reduction in the value of the reserves through production
is economic depletion. Through the depletion allowance,
a minimum of 15% of the gross income from the sale of oil
and gas is tax free. Higher tax free allowables may be available
depending on each individual's particular tax situation.
(See Section 513A of The Code.)
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