Our U.S. economy for the past seven years can be summed up in two words, “It Sucks”. Hard earned money is being sucked from the American consumers because of higher costs for goods and services. There is only one thing that should be on an investor’s mind and that is capital preservation.

Many so called experts and analysts did not think gold would be where it’s at today, or oil reaching $100 a barrel or how weak the U.S. dollar would become. Today, smart investors are laughing all the way to the bank because they were dismissed as fools a few years ago.

Savvy investors foresaw the dire economic situation and hedged their portfolios with oil, currency and gold investments. By doing so, in a balanced portfolio they have offset any losses in their stock portfolios. Their buying power is not affected because of the profits from the oil and gold investments. They are also paying less taxes this year.

An additional way of preserving your hard earn money is by investing in a “tax shelter” type of investment. The less tax you pay the more money remains in your pockets. There are currently many oil and gas Joint Ventures and Direct Participation Programs that accredited investors can take a stake in. Oil and gas prices are forecasted to continue to rise, which means a potential to make both high return on investment plus receiving tax advantages.

“Direct participation oil and gas can generate several tax benefits. These benefits range from large up front deductions for intangible drilling costs (IDC), to tax credits for the development of certain types of tight formations. Deductions are generated mainly from the cost of non salvageable equipment or services conducted during the drilling phase, testing, and/or completion of the well.” -Western Capital Inc.

Finding one of these programs is not hard to do. Just do a search on one of the major search engines for oil/gas JVs or direct participation program and you will get a listing. Usually if you qualify, you can contact them online for a prospectus. Profitability and tax benefits all depends on current tax codes, the structure of the investment program and the experiences of the partners.

Here is an excerpt from the Houston Chronicle, October 12, 2004 on the Tax Advantages of Oil and Gas Drilling:

Intangible Drilling Cost Tax Deduction
The intangible expenditures of drilling (labor, chemicals, mud, grease, etc.) are usually about (65 to 80%) of the cost of a well. These expenditures are considered “Intangible Drilling Cost (IDC)”, which is 100% deductible during the first year. For example, a $100,000 investment would yield up to $75,000 in tax deductions during the first year of the venture. These deductions are available in the year the money was invested, even if the well does not start drilling until March 31 of the year following the contribution of capital. (See Section 263 of the Tax Code.)

Tangible Drilling Cost Tax Deduction
The total amount of the investment allocated to the equipment “Tangible Drilling Costs (TDC)” is 100% tax deductible. In the example above, the remaining tangible costs ($25,000) may be deducted as depreciation over a seven-year period. (See Section 263 of the Tax Code.)

Active vs. Passive Income
The Tax Reform Act of 1986 introduced into the Tax Code the concepts of “Passive” income and “Active” income. The Act prohibits the offsetting of losses from Passive activities against income from Active businesses. The Tax Code specifically states that a Working Interest in an oil and gas well is not a “Passive” Activity, therefore, deductions can be offset against income from active stock trades, business income, salaries, etc. (See Section 469(c)(3) of the Tax Code).

Small Producers Tax Exemption
The 1990 Tax Act provided some special tax advantages for small companies and individuals. This tax incentive, known as the “Percentage Depletion Allowance”, is specifically intended to encourage participation in oil and gas drilling. This tax benefit is not available to large oil companies, retail petroleum marketers, or refiners that process more than 50,000 barrels per day. It is also not available for entities owning more than 1,000 barrels of oil (or 6,000,000 cubic feet of gas) average daily production. The “Small Producers Exemption” allows 15% of the Gross Income (not Net Income) from an oil and gas producing property to be tax-free.

Lease Costs
Lease costs (purchase of leases, minerals, etc.), sales expenses, legal expenses, administrative accounting, and Lease Operating Costs (LOC) are also 100% tax deductible through cost depletion.

Alternative Minimum Tax
Prior to the 1992 Tax Act, working interest participants in oil and gas ventures were subject to the normal Alternative Minimum Tax to the extent that this tax exceeded their regular tax. This Tax Act specifically exempted Intangible Drilling Cost as a Tax Preference Item. “Alternative Minimum Taxable Income” generally consists of adjusted gross income, minus allowable Alternative Minimum Tax itemized deduction, plus the sum of tax preference items and adjustments. “Tax preference items” are preferences existing in the Code to greatly reduce or eliminate regular income taxation. Included within this group are deductions for excess Intangible Drilling and Development Costs and the deduction for depletion allowable for a taxable year over the adjusted basis in the Drilling Acreage and the wells thereon.

From Houston Chronicle, October 12, 2004

Investing in oil and gas drilling comes with risks. As always proper due diligence should be performed and seek the advice of a tax advisor for current tax laws regarding oil/gas investments.