powerful tax advantages of oil and gas investing

Important Tax Advantages of Oil and Gas Investing

P L A T F O R M

P L A T F O R M

Speakers

Casey Minshew is the COO and a Co-Founder

of EnergyFunders. He is an avid entrepreneur,

with over 15 years of start-up expertise.

Wesley Middleton is a CPA and an entrepreneur with over

20 years of experience in oil and gas, construction and

manufacturing. Wesley is also a managing tax partner at the

prestigious accounting firm of Middleton Raines+Zapata, LLP.

For informational purposes only. Consult your own tax, legal and accounting advisors before engaging in any transaction.

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P L A T F O R M

We are a top tier CPA Firm in Houston, Texas with Oil &

Gas, Construction, Manufacturing, Healthcare, 401k Audit

and Professional Services expertise. In addition to the

audit and tax services we provide to these industries, we

provide FAS109 and FIN48 services to SEC companies

and tax consulting and compliance services to SEC

companies and officers.

MRZ was named to the 2016 list of Houston's Best and

Brightest Companies to Work For by the National

Association for Business Resources.

3Who is Middleton Raines+ Zapata?


P L A T F O R M

• EnergyFunders.com is an online investment marketplace disrupting the energy

industry by evolving the way capital investment and energy projects come

together to generate more profitable commerce.

• Founded in 2013, the Houston-based fintech company currently offers

professionally vetted oil and gas projects as financial opportunities for

accredited investors nationwide and internationally with minimum investments

amount of $5,000. In the aggregate, several million has been raised on the

EnergyFunders.com platform.


About EnergyFunders 4

P L A T F O R M

Legal Disclosures

EnergyFunders, LLC, and its affiliates, subsidiaries, parent companies, managers, officers,

employees, and agents, do not provide tax, legal, investment, or accounting advice and are not

providing you with tax, legal, investment, or accounting advice through this presentation.

Middleton Raines+Zapata, LLP, is not providing you with tax, legal, investment, or accounting

advice through this presentation. This material has been prepared for informational purposes

only, and is not intended to provide, and should not be relied on for, tax, legal, investment or

accounting advice. You should consult your own tax, legal, investment, and accounting advisors

before engaging in any transaction. By viewing this presentation, you acknowledge and agree

that you are not relying upon this presentation for any tax, legal, investment, or accounting

advice and will consult your own advisors before engaging in any transaction.


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P L A T F O R M

What is so powerful about Oil & Gas Tax Deductions?


Deduct up to

100% of your

investment

over 7 years

Up to 80% can be

deducted in the

year you make

the investment

You only pay

tax on only 85%

of the revenue

you receive

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P L A T F O R M

• In 1986, Congress passed a bipartisan, sweeping piece of legislation entitled

the “Tax Reform Act of 1986.” This bill established specific considerations

related to domestic oil and gas development, creating what Newsweek would

later say, “is the very best tax advantaged Investment.”

• Specifically, Intangible Drilling Cost (IDCs) were allowed to be deducted

against active income. Typically, oil and gas exploration has been considered a

passive activity for most investors. From a tax perspective, this changed under

Reagan and the Tax Reform Act.


Reagan Tax Reform Act of 1986 7

P L A T F O R M

• Intangible Drilling Cost (IDC) Deduction – The intangible expenditures of drilling (labor,

chemicals, drilling mud etc.) typically 60-80% of drilling, re-working or re-completing wells.

The IDC is 100% deductible in the first year. (Ex: A $100,000 investment would yield up to

$75,000 in deductions against taxes on active income in the first year of the venture.)

• Tangible Drilling Cost (TDC) Deduction – The total amount of the investment allocated

to equipment may be 100% tax deductible. Using the above example, about $25,000 may

be deducted as depreciation over a 7-year period.

• Accordingly, you could deduct your entire investment over 7 years, no matter the level of

success of the project in which you invested.


Tax Incentives for Oil and Gas Investing 8

P L A T F O R M

• Depletion Deduction – This deduction excludes from taxation 15% of all gross

income from oil and gas wells. This special advantage is limited solely to small

companies and investors. Any company that produces or refines more than

50,000 barrels of oil per day is ineligible. Entities that own more than 1,000 barrels of oil

per day, or 6 million cubic feet of gas per day, are excluded as well. Thus, investments in

projects operated by many smaller operators would allow an investor to take advantage

of this deduction.

• Example: If you earn $10,000 in income on your oil and gas investment, and claim the

deduction, you would pay taxes on only $8,500 of the income. $1,500 of the income is

excluded from taxation.


Tax Incentives for Oil and Gas Investing (cont.) 9

P L A T F O R M

• The income from an oil and gas property is usually divided between the mineral interest owner (the

royalty owner) and the operator (the working interest owner).

• Net revenue interest is the total revenue interest that an entity owns in a particular oil or gas production

unit, such as a lease, well, or drilling unit. In a typical lease arrangement, the royalty owner retains a

12.5% - 25% net revenue interest and the working interest owner owns a 87.5% - 75% net revenue

interest.

• The royalty owner owns a right to receive income. The working interest owner has liability for expenses

but also owns the right to receive income. The working interest is subject to all of the costs of exploring

for, developing, and producing the minerals. The holder of the working interest can retain ownership

throughout the life of the lease or assign all or part of the interest during the term of the lease.

• The royalty owner incurs none of the cost to explore, develop, or operate the mineral production.


What is a Working Interest? 10

P L A T F O R M

• Costs to explore, develop, or operate the mineral production are borne by the

working interest owner.

• This is where the investor comes into play. In order to fund the exploration,

development, or operations, the working interest owner transfers various interests

in the property to the investor in exchange for their capital.

• As the operator begins the exploration and development of the property, these

costs are allocated to the investor. In the beginning, these are geological survey

costs, well equipment (also called tangible costs), and intangible drilling (IDC)

costs which, for tax purposes, are allowed to be deducted rather than capitalized.


What is a Working Interest? (cont.) 11

P L A T F O R M

• The partnership passes these IDCs through separately to the investors on the

Schedule K-1. As an investor, you will receive an annual Schedule K-1 for each

investment.

• Normally these passive activity losses would only be deductible to the extent that the

investor has passive income.

• But if you own a working interest in any oil or gas property, either directly or through

an entity that doesn't limit the taxpayer's liability with respect to the interest, it is non-

passive activity (that is, active activity), regardless of the taxpayer's participation,

and may be deducted against earned income.


Why would I want a Working Interest investment? 12

P L A T F O R M

For the purposes of this rule, an entity limits the liability of the taxpayer if the

interest in the entity is in the form of:

• a limited partnership interest in a partnership in which the taxpayer isn't a

general partner;

• stock in a corporation; or

• an interest in any other entity that, under applicable state law, limits the

potential liability of the holder of an interest for all obligations to a

determinable fixed amount – such as an LLC or similar entity type.

For informational purposes only. Consult your own tax, legal and accounting advisors before engaging in any transaction..

What Limits a Taxpayer’s Liability? 13

P L A T F O R M

• One of the most common solutions to this problem is to simply use a limited

partnership as the investment vehicle but have an investor invest as an

“Investor General Partner” that converts to an “Investor Limited Partner” upon

production or after the development of the project is completed. This is the

best of both worlds!

• As an investor, this causes your investment to be non-passive (i.e., “active”)

during the development of the project, which allows you to take this

deduction against your earned income.

For informational purposes only. Consult your own tax, legal and accounting advisors before engaging in any transaction..

How can you make the investment active? 14

P L A T F O R M

• Investors who elect to invest as general partners in order to take full advantage of

the available tax benefits will be directly liable for the liabilities of the partnership if

any liabilities are incurred while they are general partners.

• If they invest as limited partners, their liability will be limited to the amount they

invest; however, their ability to use the IDC deductions to offset income from

salaries and other non-passive income will be eliminated.

• In addition, a general partnership interest cannot be owned directly or indirectly

through an entity that limits the investor’s liability. The risks must be to the

individual investor.

• In order to mitigate these risks, an oil and gas partnership typically will provide

insurance against certain risks.


What are some of the risks when investing as a General Partner?

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P L A T F O R M

• Operators are required to hold a Commercial General Liability (CGL) policy

in an industry-standard amount that covers various known foreseeable risks.

• Along with and through its manager, each limited partnership or fund is a

named insured on a $2 Million/$1 Million/$10,000 SIR CGL and a $5 Million

Umbrella Excess policy.

• An Investor General Partner converts to an Investor Limited Partner after

development of the project is complete so that the investor can claim IDC

deductions against earned income but limit his or her liability going forward.

• Operators usually require third party companies to use subcontractors who

also carry CGL’s.


Risk Mitigation Typically Provided on the EnergyFunders Platform to Investors

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P L A T F O R M

• Deduct or Capitalize: Deduct in Year 1 or Capitalize over 60 months.

• How to make the election: You elect to deduct IDCs as a current business expense by

taking the deduction on your income tax return for the first tax year you have eligible

costs. No formal statement is required. If you file Schedule C (Form 1040), enter these

costs under “other expenses.”

• Nonproductive well: If you capitalize your IDCs, you have another option if the well is

nonproductive. You can deduct the IDCs of the nonproductive well as an ordinary loss.

See: https://www.irs.gov/publications/p535/ch07.html for more details


How to Take the Deductions on Your Tax Return 17

https://www.irs.gov/publications/p535/ch07.html

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