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Trade Up 1031 offers access to energy programs that capitalize on global economic and market conditions and provide opportunities for investors to diversify into world markets.
Whether you're contemplating oil and gas drilling programs which offer significant tax incentives or considering executing a 1031 exchange into working or royalty mineral interests,
Trade Up 1031 stands ready to assist you.
Congressional Incentives Encourage Domestic Petroleum Development
Oil and natural gas from domestic reserves helps to make our country more energy self-sufficient by reducing our dependence on foreign imports. Congress has provided favorable tax incentives to stimulate domestic natural gas and oil production financed by private sources. These incentives are not "loop holes" -- they were placed in the Tax Code by Congress to make participation in oil and gas drilling ventures a tax-advantaged investment for individuals and small companies.
Intangible Drilling Cost Tax Deduction
The intangible expenditures of drilling—labor, chemicals, mud, grease, etc.—are usually about 70% to 100% of the cost of a well. These expenditures are considered Intangible Drilling Costs (IDC) which are 70% to 100% deductible during the first year. For example, a $100,000 investment could yield
between $70,000 to $100,000 in tax deductions during the first year of the venture
for the purchaser. 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
Tangible Drilling Costs (TDC) refer to the expenditures for tangible property—equipment such as drilling tools, pipe, casing, tanks, tubing, engines, and machines. TDC's are 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.
Real estate investors are familiar with title to property above the ground. But title also exists below the ground in the form of Mineral Interests which actually supersede surface rights. In the oil and gas industry, these Mineral Interests are typically split into Working Interests (drillers and operators) and Royalty Interests (passive owners of the original Mineral Interest).
When it comes to tax deferred exchanges of investment properties, many people are unaware that their choices can extend beyond traditional real estate into certain types of oil and gas investments.
Federal law determines whether an interest in oil and gas is real property, regardless of its characterization within state law (IRS Rev. Rul. 68-226; IRS Rev. Rul 68-331). Both a working interest and a royalty interest qualify as "like-kind" real estate when executing a 1031 exchange.
The beauty of a 1031 exchange is that you can defer capital gains taxes saving you up to 15% in federal taxes, 25% depreciation recapture, in addition to your state capital gains taxes, for example 9.3% in California. A 1031 exchange is one of the most powerful tax deferral strategies available.
In addition to tax deferral, energy interests may offer investors the potential for steady monthly cash flow and double-digit annual rates of returns.
Energy investments may not be appropriate for everyone depending on their age, net worth, annual income, investment objectives, investment portfolio, and other financial information. Interests are offered to accredited investors only and are suitable to individuals able and willing to assume the risk of a speculative, illiquid, and long-term investment.
The quality of your investment will depend on the productivity of the wells, their volume of production, and overall economic and market factors influencing energy costs. It's important to remember that a natural gas or oil well is a naturally depleting asset. Over time, reduced production volumes will typically result in lower returns.
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