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Tax
Information
for Joint Venture
Drilling Programs
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Tax
Write Offs |
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Tax
Shelter Investment Information |
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Benefits
of Oil and Gas Partnerships |
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INVESTOR'S BUSINESS
DAILY
Drill for Year End Write Offs in Oil and Gas Drilling
Programs
Exploring for a year-end tax deduction? Sinking some
dollars into an oil and natural gas drilling deal can
be risky. But such investments can offer robust returns
as well as write-offs.
One benefit provided by the tax code is an upfront tax
deduction. "Often, a large portion of your investments
may be deducted in the first year," said Ronald Rutherford,
a certified financial planner in New York. In other
types of business, more of the costs must be written
off over long time periods.
The amount you can deduct would vary according to details
of the transaction. But suppose you invest $25,000 in
a drilling deal this year. Say you get to deduct $18,000
from your 2007 income. In a top 39.6% federal tax bracket,
that deduction would save you more than $7,000 in tax
payments. State tax deduction might increase your total
savings.
Depletion Allowance
If your drilling investments find oil or gas, you may
get revenue starting in late 2007 or 2009. Then your
taxable income will be reduced by depletion allowance.
That's a second tax break to encourage energy exploration.
It assumes the well in which you've invested loses value
as the energy resource is pumped out. You can treat
part of your revenue as a nontaxable refund of your
original investments rather than as taxable income.
Imagine you're paid $4,000 in 2007 for your 2007 investments.
Because of the depletion allowance, you might have to
report only, say, $3,000 as taxable income. The exact
amount will vary each year, depending on factors such
as the amount of oil and gas produced and income reinvested.
This shelter can go on as long as the oil and gas keeps
flowing.
A third reason to consider making this type of investment
is for the sake of diversifying your portfolio. When
stocks or bonds are weak, oil and natural gas prices
may rise. Despite these benefits, there are risks. Mainly,
the driller might not discover enough oil and gas.
Check Background
One precaution is to check the background of the management
running the drilling operation. Ask to see letters to
investors in prior deals to see if the operators actually
sold oil or gas and distributed cash. The type of drilling
that's planned can impact your return. "Wildcat" exploration
looks for previously undiscovered petroleum. On the
other hand, "developmental" drilling takes place near
fields already producing oil and gas. Such drilling
probably won't produce a bonanza but very likely will
find some petroleum to sell.
"Ask to see a map of the area to be drilled," Rutherford
said. "There will be less risk if the wells are in the
middle of a producing oil or gas field rather than on
the outskirts. And check with your tax pro. "These programs
raise issues regarding the alternative minimum tax,
the passive-activity rules and the at-risk rules," says
Robert Keebler, partner in the accounting firm Virchow,
Krause and Co. of Green Bay, WI. "They should be addressed
before you invest or you may not receive the upfront
deductions you expect," Keebler said. Keebler points
to another potential tax advantage concerning Roth IRA
conversions. Regular IRA's may be converted to Roth
IRA's. Deferred income taxes are due upon conversions.
AIGI Matters
But you can eventually withdraw all of the money in
a Roth IRA tax-free after the latter of five years of
age 59 ½ , You are eligible to convert only in
a year when your adjusted gross income is $100,000 or
less. "The first-year deductions from a drilling income
below $100,000 for the year," Keebler said. "Nevertheless,
the underlying economics are critical, so you should
pay attention to the investments potential as well as
the tax advantages."
Brokers and Advisers
Oil and gas drilling deals may be available through
some brokers, financial planners, accountants and other
advisers or directly from the sponsoring oil company.
These investments typically are structured as partnerships
or joint ventures. Some may require you to have a specific
level of income or net worth to participate. Don't ignore
risks. Oil prices have soared the past two years to
record levels and so has the price of natural gas. Although
it seems highly unlikely at this time, they can always
plummet in the future and reduce your income.
Very few investments enjoy the pure tax shelter benefits
by investing in drilling for reserves of oil and natural
gas. In a successful drilling deal you may have your
cake and eat it too, from the upfront tax deductions
to ongoing tax sheltered cash flow.
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THE
MOST FREQUENTLY ASKED QUESTIONS …
AND ANSWERS REGARDING TAX BENEFITS FOR ALTEC PETROLEUM
GROUP JOINT VENTURE DRILLING PROGRAMS
We would like to take this opportunity to briefly outline
answers to a few of the question we are often asked
about the tax considerations of participating in our
joint venture oil and gas drilling programs.
Q: What type of information do you receive from Altec
Petroleum Group, Inc. to show you how to claim your
tax deductions from investing in our drilling programs?
A: Within a reasonable time after the close of each
accounting year, the Managing Venturer (Altec Petroleum
Group, Inc.) shall send to each venturer a report (in
the form of Schedule K-1 to IRS Form 1065) indicating
that person's distributive share of all tax items. The
income and deductions reflected on your K-1 is then
used in preparing your federal tax return.
Q: What IRS tax code determines if your investment in
our drilling programs is tax deductible?
A: Numerous code sections apply. Most importantly, under
Section 469(c) (3) (the "working interest exception"),
working interests in oil and gas properties are not
treated as "passive activities" if the taxpayer owns
the interest directly or through and entity that does
not limit his liability with respect to the activity.
Two elements must be met before a taxpayer qualifies
for the working interest exceptions to the passive activity
loss rules, so that losses will not be treated as losses
from passive activity. First, the property generating
losses must constitute a "working interest" as defined
by the passive loss rules. Second, the interest must
not be held through an entity that limits the liability
of the taxpayer with regard to the activity.
Q: Can individuals reduce their income from other sources
with deductions generated by Altec Petroleum Group's
joint ventures that own oil and gas working interests?
A: Generally yes, because the deductions generated Altec
Petroleum Group's Joint venture oil and gas working
interests are not treated as "passive losses". The Tax
Reform Act of 1986 provides that, in most cases, deductions
generated after 1986 from investments in which an individual
does not materially participate are treated as "passive
losses" and cam be deducted only against "passive income".
Deductions classified as "passive losses" cannot offset
income such as wages, interest, or income from many
businesses in which the individual materially participates.
However, the law contains an exception, Section 469
(c) (3) under which, among other things, deductions
generated by oil and gas working interest (as opposed
to royalty interest) owned through general partnerships
are not considered "passive losses," so partners and
the joint venture subsequently generated by such ventures
will not be treated as "passive income."
Q: What are some of the tax deductions from Altec Petroleum
Group's oil and gas drilling programs?
A: Our oil and gas drilling programs are specifically
designed to generate various tax deductions from drilling,
completing and producing oil and gas wells. These deductions
include intangible drilling cost (IDC), depreciation,
and operating costs. In addition, when production is
achieved, our ventures claim a depletion deduction against
their share of the venture's income from oil and gas
produced.
Q: What other deductions are generated by Altec Petroleum
Group's oil an gas drilling ventures?
A: Our ventures drill and at times operate oil and /
or gas wells. We are defined as being engaged in a "trade
or business" and therefore claim as a deduction, for
federal tax purposes, all ordinary and necessary expenses
paid in carrying on our "trade or business," such as
costs of operating well, general and administrative
costs of the venture, and certain fees paid to the managing
venturer.
Q: What are Intangible Drilling Costs (IDC)?
A: These IDC costs include expenditures for wages, fuel,
repairs, hauling, supplies and other items that have
no salvage value and are necessary for the drilling
of wells (i.e. hiring the drilling contractor) and the
preparation of wells for the production of oil and gas.
Intangible costs generally represent a majority of the
total cost of drilling, testing and completing an oil
and / or gas well.
Q: How do Intangible Drilling Costs (IDC) produce tax
benefits for our joint venture?
A: The joint venture drilling a well may elect to deduct
intangible drilling costs, so its investors can get
an immediate benefit from the expenditure. When the
well drilled proves to be commercially productive, an
election to deduct IDC's will generally result in a
tax benefit to ventures (in the form of tax deductions)
in the year the well is drilled. However, if the oil
and gas property or an interest in the venture is later
sold at a gain, all or a portion of that gain may be
classified as ordinary income because of the recapture
of these deductions.
Q: Can I deduct depreciation on tangible items purchased
to equip on oil or gas well?
A: Yes. While it is true oil and gas drilling ventures
cannot deduct the entire cost of items purchased to
equip an oil or gas well in the year of purchase, those
costs are capitalized and can be depreciated over a
period of five or seven years (depending on when the
particular property is placed in service and on its
depreciable "class life"). Consequently, an investor
could deduct his share of the depreciation on items
such as casing, tubing and pumping units. If such equipment
is later sold for more that the depreciated value or
if a venture sell his venture interest, all or portion
of the gain may be classified as ordinary income because
of the recapture of depreciation deductions.
Q: What is "depletion" and how does it reduce or defer
an investor's taxes?
A: Depletion allows the owner of producing oil and /
or gas well to recover his capitalized cost through
tax deduction over the period in which the oil and/or
gas is produced. Consequently, a venture generally cannot
deduct in the first year the entire purchase price of
an oil or gas leasehold interest or other oil or gas
property interest. However, when a producing well is
drilled, the venture can recover the cost of the oil
and gas property through depletion deductions. An investor's
depletion deduction is computed individually by the
joint venture. A venture makes this computation based
on the portion of the properties adjusted tax basis
that the venture allocates to they venture. If the property
is later sold at a profit or a venture sells his venture
interest, all or a portion of the profit bay be classified
as ordinary income because or the recapture of deductions.
If the venture drills a dry hold and the lease is worthless,
the total capitalizations of the oil or gas venture
can be deducted in the year it is determined to be worthless.
Q: What is the difference between cost depletion and
percentage depletion?
A: Cost depletion allows a recovery each year of a portion
of the capitalized cost, including the cost of the oil
and gas lease, of a producing well over its life. The
portion of those costs that can be recovered each year
is based on the percentage of the estimated recoverable
oil and gas reserve sold during each year.
Percentage depletion, on the other hand, is computed
on the basis of the income from the property rather
than the cost of the property. Percentage depletion
often results in a larger deduction than the cost depletion
because it may be taken over the entire productive life
of the property, even through the total deduction claimed
exceeds the capitalized cost of the property. Percentage
depletion, however, is generally only available to independent
producers who received an interest in the property before
the property was considered to be "proven property"
for federal income tax purpose. Certain other restrictions
also apply.
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TAX
WRITE OFFS WORKSHEET
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Example of an investor
in an Altec Petroleum Group Joint Venture potential
tax benefits. Each investor’s tax liabilities
are different. Consult with your personal tax
advisor regarding the potential benefits of oil
and gas Joint Venture participation. The example
below assumes an investor in a 35% Federal Income
Tax Bracket, 2.9% Medicare Tax and a 3% State
Income Tax.
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Investment
Amount Example
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$30,000
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First
Year Deductions:
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Intangible
Drilling Cost (76%) & other deductible expenses
pursuant to IRS Section 469 (c)(3)
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($30,000
x 75%) = $22,500
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Tangible
Well Equipment (9%) Written off per IRS Section
179
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($30,000 x 9%) = $2,700
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First
Year Deductions on Tax Return
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($22,500
+ $2,700) = $25,200
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First
Year Tax Savings from Investing
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($25,200
x 40.9%) = $10,307
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Net
out of Pocket Cost for a $30,000 Investment Unit
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($30,000
- $10,307) = $19,693
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SUMMARY
Therefore,
a joint venture participant can save approximately
$10,300 in direct tax savings per ($30,000)
invested.
Financial
Statements and Tax Returns. At the expense
of the Joint Venture, the Managing Venturer shall
engage a certified public accountant to prepare
the Joint ventures’ annual income tax return
as required by Code requirements relating to sales
and exchanges of interests in the Joint Venture,
and annual financial statements, which shall include:
(a)
a statement of income or loss for the full
year;
(b) a statement of changes in financial position;
(c) a statement of cash flow and distributions
for the full year; and
(d) a detailed statement of assessments and
borrowing, if any. |
Within a reasonable time after the close of each
accounting year, the Managing Venturer shall transmit
to each person who was a Venturer (or investor)
during such accounting year, a copy of such financial
statements and a report (which may be in the form
of Schedule K-1 to IRS Form 1065 or the Venture
may issue 1099’s in lieu of Schedule K-1)
indicating such persons’ respective share
of Federal Income Tax Items, Amount Realized,
tax preference items and investment credits, if
any, for such year.
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PERSONAL WORKSHEET
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Amount
of Investments
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_________Line 1
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Multiply
Line 1 by 76% = Approximate amount of Intangible
Drilling Cost
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_________Line 2
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Multiply
Line 1 by 9% = Tangible Equipment Deduction pursuant
to IRS Section 179
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_________Line 3
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Add
Lines 2and3 = First Year Deductions
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_________Line 4
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Enter
your overall Tax Bracket (Federal, State and Medicare)
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_________Line 5
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Multiply
Line 4and5 = First Year Tax Saving
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_________Line 6
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Subtract
Line 6 from Line 1 = Net Out of Pocket Investment
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_________Line 7
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