Oil and Gas Tax Deductions
Evans Sternau CPA provides tax advisory services to sophisticated taxpayers to ensure they are receiving all allowable oil and gas tax deductions.
Intangible Drilling Costs
Developing an oil and gas well requires a significant amount of cost. These costs are separated into two categories for tax purposes, intangible and tangible. Intangible drilling costs (IDCs) are costs that have no salvage value. Examples of intangible drilling costs include, cost of drilling, administrative costs associated with drilling, costs to construct roads to drill site, and surface damage payments to owners.
The intangible drilling cost is one of the most attractive tax aspects of oil and gas investments. Investors who incur intangible drilling costs are allowed the option to either expense IDCs when incurred or capitalize IDCs and amortize the costs over 60 months. Sophisticated taxpayers should consult with an experienced CPA who can prepare multi-year tax plans to determine if deducting or capitalizing IDCs is best.
Tangible Costs – Lease and Well Equipment
Lease and well equipment are tangible costs that are equipment and facilities used on the lease for the production of oil and gas. These costs are differentiated from IDCs in that tangible costs have a salvageable value.
The tangible costs incurred are capitalized and depreciated over seven years. For the past several years, taxpayers have enjoyed the tax benefits of 100 percent bonus depreciation of lease and well equipment. The bonus depreciation deduction has already begun to phase out and will be fully phased out by 2027.
Similar to IDCs, sophisticated taxpayers should consult with an experienced CPA who can prepare multi-year tax plans to determine if the taxpayer should utilize bonus depreciation or choose to depreciate over seven years.
Oil and gas properties are wasting assets and such, taxpayers are entitled to a depletion deduction to recover the cost they paid to acquire the leasehold. There are two methods available for computing depletion, cost depletion and percentage depletion.
The percentage depletion deduction is a deduction based on the revenue of the property. The percentage depletion deduction is 15% of the gross revenue of the property.
The cost depletion deduction is based on a units of production method. In order to receive benefit from cost depletion, the taxpayer must have a basis in the leasehold, know the amount of reserves, and know the amount of oil and gas produced.
An attractive tax benefit of percentage depletion is that is still available after the basis of the property has been fully recovered.
About The Author
Christopher Sternau, CFP®, CPA
Partner – Evans Sternau CPA LLC
Christopher Sternau is a Certified Public Accountant and Certified Financial Planner with over a decade of experience providing comprehensive tax and financial planning services to several of the wealthiest families in the United States. He focuses his practice on complex individual and closely held business tax planning and preparation. His clients have business interests in a wide range of industries including oil and gas, mining, real estate, cattle ranching, retail, technology and many others.
Chris is the founding member of Evans Sternau CPA LLC. Prior to founding Evans Sternau CPA LLC, Chris led the tax department for a family office in Houston, Texas. He also spent several years as a Tax Manager at Andersen.
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