Hunter Shields
Contact

Oil-and-gas tax considerations

United States tax law treats some costs of drilling and operating oil and gas wells differently from ordinary investment costs. The two provisions most often discussed are the election to deduct intangible drilling and development costs, and depletion.

Sources last reviewed

The moving parts

What has to be in view first.

A different set of deduction rules, available to a particular kind of ownership interest — and only to that kind.

Working interest
An ownership interest that bears a share of the costs of drilling and operating. The intangible drilling cost election is available to taxpayers holding a working or operating interest in an oil or gas property.
Royalty interest
A right to a share of production revenue without bearing operating costs. It is a different interest with different tax consequences.
Intangible drilling costs
Costs of drilling and development that have no salvage value. Section 263(c) authorises regulations under which a holder of a working or operating interest may elect to deduct them, with amortisation over 60 months as an alternative.
Depletion
A deduction recognising the exhaustion of a mineral property. The IRS states that percentage depletion for oil and gas generally cannot exceed 100% of taxable income from the property computed without the depletion deduction, and that it is generally unavailable unless the taxpayer is an independent producer or royalty owner.

The shape of it

The interest decides the treatment.

A working interest bears drilling and operating costs and may elect to deduct intangible drilling costs; a royalty interest receives revenue without bearing those costs and has different tax consequences.Two columns compare the two interests. The working interest column shows revenue in and costs borne, with the intangible drilling cost election available. The royalty interest column shows revenue in, no costs borne, and no intangible drilling cost election.WORKING INTERESTReceives a share of revenueBears a share of the costsIDC ELECTION AVAILABLEROYALTY INTERESTReceives a share of revenueBears none of the costsNO IDC ELECTION
The provisions attach to the kind of interest held, not to the commodity. Exposure to energy prices through a listed fund is a different thing again.

The interest determines the treatment

The distinguishing feature of these provisions is not the commodity — it is the kind of interest held. The intangible drilling cost election attaches to a working or operating interest in the property, which is the interest that bears the costs.

Buying exposure to energy prices through a listed fund is a different thing from holding a working interest in a well. Only one of them puts these provisions in play, and only one of them carries the associated obligations.

A deduction is not a return

A deduction reduces taxable income. It does not change whether a well produces. The geological and commodity-price risk sits entirely outside the tax treatment, and a favourable deduction on a well that does not produce is still a loss.

Reading the two separately — what the investment does, then what the tax treatment does — keeps the tax attribute from standing in for an economic case.

Where these investments usually appear

Drilling programmes are commonly offered as private placements with investor qualification requirements. Wealth Watch Advisors’ current brochure describes one such vehicle — GrayStreet Drilling Fund II, LLC, an oil and gas development drilling fund — as available to eligible accredited investor clients, subject to a specialised fee structure and a separate disclosures and fee supplement.

Those terms belong to that specific offering. They illustrate the shape of the category rather than defining it.

Trade-offs

What is given up, and to whom.

  • The deduction provisions attach to a working or operating interest, not to indirect exposure through a fund.
  • A working interest brings a share of costs and liabilities, not only a share of revenue.
  • Percentage depletion is subject to statutory limits and is generally unavailable except to independent producers and royalty owners.
  • Drilling outcomes are geological; the tax treatment does not affect whether a well produces.
  • These programmes are typically illiquid private placements restricted to qualifying investors.
  • Reporting is more involved than a listed security, including partnership reporting and potential filings in the state of operations.

Questions before conclusions

What to ask before anything else.

  1. What interest am I actually acquiring — working, royalty, or an interest in a fund that holds one?

  2. Which specific deductions is this expected to generate, and on what authority?

  3. What does the economics look like with no tax treatment at all?

  4. What costs and obligations come with the interest, not just what revenue?

  5. What has to be filed, where, and for how many years?

Direct answers

Common questions about oil-and-gas tax considerations.

What are intangible drilling costs?

Intangible drilling and development costs are costs of drilling and developing an oil or gas well that have no salvage value. Section 263(c) of the Internal Revenue Code authorises regulations under which taxpayers holding a working or operating interest in an oil or gas property may elect to deduct these costs, and the IRS also describes amortisation over a 60-month period as an alternative.

Who can claim the intangible drilling cost deduction?

The election described in section 263(c) is available to taxpayers who hold a working or operating interest in the oil or gas property. Holding a royalty interest, or holding shares in a listed fund with energy exposure, is a different form of ownership with different tax consequences.

How is percentage depletion limited for oil and gas?

The IRS states that the percentage depletion deduction generally cannot be more than 100% of taxable income from an oil and gas property, figured without the depletion deduction, and that unless you are an independent producer or royalty owner you generally cannot use percentage depletion for oil and gas wells.

Do oil and gas tax deductions make the investment safer?

No. A deduction reduces taxable income; it does not affect whether a well produces or what the commodity is worth. The geological and price risk of the underlying investment is unchanged by its tax treatment.

Sources

Where every statement here comes from.

Each source below was read in full on the date shown. Where a publisher stamps its own revision date, that is shown too — a page can be reviewed recently and still be based on something the publisher changed long ago.

Think something here is wrong or out of date? Send a correction

Important context

This is an explanation, not advice.

This page explains how a category works. It is not a recommendation, an offer, a statement that Hunter Shields provides or advises on it, or a claim about availability, eligibility, tax treatment, or outcome for any particular person. Nothing here is tax advice, and no tax result is promised. Tax outcomes depend on individual circumstances and should be confirmed with a qualified tax professional.

Continue exploring

Back to the areas of focusAsk a question about this