The federal income tax code provides several incentives to encourage investments in oil exploration. Because of the unique nature of oil drilling and production, the tax incentives are somewhat different than those of other industries. Individual investors can receive early tax deductions and ongoing revenue by investing in an oil partnership. Unlike a corporation, an oil partnership is not directly subject to taxation. No income tax is paid at the entity level, and all tax attributes pass from the partnership to the individual partners. After the end of each tax year, the partnership sends an IRS Form K-1 statement to each partner to summarize the operating results. The Form 1040 for each partner is then prepared based on the tax attributes reported on Form K-1.
Intangible drilling costs
The intangible costs of drilling a new oil well can be deducted in the year in which development begins. For the oil industry, the definition of intangible costs is expanded to include additional expense categories such as labor and transportation. Although other industries typically deduct start-up costs over several years, the ability to deduct drilling costs in the first year provides a substantial deduction to each partner.
Depletion allowance
Depletion is a tax deduction for the gradual usage and reduction of a natural asset. A smaller partnership that owns no more than 1,000 barrels of oil per day may exclude 15 percent of its revenue from taxation as a depletion expense. As with all other tax attributes, the depletion deduction is passed through to you from the partnership.
Passive income exception
For individual tax purposes, a loss from a passive investment generally cannot be used to offset active income such as wages. If a limited partner incurs a passive loss, the loss can be used only to reduce passive income. However, an exception applies for a general partner in an oil partnership.
A general partner is considered to have a working interest in the partnership. Because of the working interest in the oil partnership, a partner's respective share of a loss may be used to offset active income. Your other sources of income may be determining factors in deciding whether to become a limited partner or a general partner.
Some oil partnerships may allow you to join as a general partner and then transition to a limited partner at a later date. There are no income restrictions on who is eligible to receive the tax benefits of investing in an oil partnership. Contact an oil partnership for more information on the benefits of becoming a partner.
To become an oil partner, click here for more information or do an online search.
Share19 November 2015
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