Oil Drilling Investments Are Tax-Advantaged

But why do billionaires choose to invest directly in oil wells instead of using mutual funds and the like?

The biggest reason is tax breaks. Now, these don't tax loops, these are tax deductions and exemptions that the Federal government wants you to use.

First - oil companies can deduct intangible drilling costs. These intangible costs are all the costs to drill, except the actual drilling equipment. They include labor and chemicals costs an average of 75 percent of the total drilling costs. All tangible drilling costs are 100 percent deductible thanks to a tax provision that’s now over 100 years old. Regardless of whether the well produces oil or not, these deductions are still allowed.

Second - there are the tangible drilling costs. This is the actual drilling equipment costs, also 100 percent deductible, but depreciated over seven years. For high net worth individuals investing directly in oil wells, they can use any losses during the early years of oil drilling to offset other sources of active income, such as capital gains and salary.

Third - there’s the most prized asset for oil drilling investments, known as the depletion allowance. The 1990 Tax Act allows 15 percent of an investor’s oil well gross income to be exempt from federal taxation. As long as the individual limits their ownership to 1,000 barrels of oil per day, they’ll get this 15 percent tax exemption.

The Newest Big Tax Breaks

Tax breaks for the oil industry are getting better and better as the Trump administration continues to push for energy independence in the U.S. The goal is to encourage the buildup of a strong energy infrastructure, and oil companies need capital to do that. The government is making investments in oil companies even more tax-advantaged to attract that capital.

Passed just before the New Year, the tax laws got their first major reform since the 1980s. The corporate tax rate has moved from 35 percent to 21 percent. But the bigger news for oil investors is that the rate for pass-through entities is now capped at 20 percent, instead of being taxed at the personal income rate. For investors that can’t invest directly in oil wells, this makes partnership investing a viable opportunity.

The government also kept all the original tax breaks mentioned above intact.

Oil drilling investments are looking better than ever. Oil prices have found a floor of sorts, although we’re still only a couple of years removed from the quick crash in prices. But with the now staple price environment, companies that have been putting off investing will likely look to deploy capital in new oil well opportunities. It should also be considered the fortuitous timing for investors as well, especially now that the big tax breaks are safe following the tax reform.