Tax planning strategies for the accredited investor using oil and gas investments
Updated: Aug 21, 2018
Direct oil and gas investments can provide for some excellent income and tax planning opportunities for today's accredited investors with over $1 million in investable assets, or annual income of above $250,000. With the stock market hitting multi year highs, it may be a perfect time to diversify out of some of your equity positions into Oil and Gas.
Oil and Gas is one of the last great tax benefits out there. I'd recommend purchasing with a development oil drilling company, one that is drilling in proven oil wells. This greatly reduces your risk, and having a working interest in the well allows you spread out your investment between multiple wells.
Everyone knows that you can get a big tax deduction from investing into oil and gas, but I tell my clients that they should focus more on total return. If you purchase an oil well, what is your exit strategy? How long will you money be tied up for?
I like to go with companies that have a proven track record of drilling and extracting oil from existing, proven oil wells. Most companies selling this investment will structure the sales deal something like this:
Cost to drill the well: $8 million.
Cost for the Land: $3-$4 million
Total Cost: $11-$12 million.
Here's how you make your money:
Most wells have about 500k of recoverable barrels of oil.
200k barrels are extracted in the first 2-3 years (40%), and if you sell the oil for $82.50/barrel, that gives you revenues of $16.5 million. A $11 million investment, has just made about 1.5 times its original investment, or 50%.
The remaining 300k barrels of oil are usually taken out over the next 30-40 years, but it doesn't have to be that way.
Instead of holding on to a depleting asset for the next 38 years, you could sell your 300k barrels of future oil, and discount the price, say for $20/barrel. This gives you an additional $6 million. Now total revenues are $22.5 million on a $11 million investment, or about 2 times your investment, a 100% gain.
Now, what if because you have a producing "proven" oil well, you go out and get a engineer's report that says you have two Proven Undeveoped Reserves (PUDS), or two additional oil wells with say, 500k barrels of oil each. The oil is there, you just have to drill the hole and go and get it. You could do that, or you could sell your interest for those future barrels of oil for say, $10/barrell. That will give you another $5 million each. Now total revenue is $32,500,000.
Your $11 million investment, has just returned 3 times your money, or a return of about 200%, all without the crazy ups and downs of the stock market. What do do you next? You do the same thing all over again.
Buyer beware, most oil and gas companies don't give you ownership to the mineral rights of the well. You'll get your initial 200k barrels of oil out in the first 2-3 years, have a nice tax deduction, and then you're stuck with the well for the next 38 years. Finding the right oil drilling partner that gives you ownership of the mineral rights is key. Once you have a proven, producing well, having the ability to sell the Proven Undeveloped Reserves (PUDS) gives you some good bang for your buck, and it gives you as the investor a built in exit strategy to make your 2 to 2.5 times your money.
If you want to get a list of the oil companies that offer this unique option, then call our office today at 303-734-7178, or schedule a 15 minute phone appointment by clicking here.
Oh, and I forgot to mention that you get a 40%-50% deduction from ordinary income on your investment, and 15% of the annual income that this investment generates is tax free, and usually will pay between 6-8%,
Split up that investment between 100 people at $100,000 each, and you have some very happy investors.
If you put $100k into the oil and gas, you can write off $40-$50,000 of ordinary income. This is income from your w-2 job, an IRA/ROTH conversion, or perhaps you had some realized capital gains. The oil and gas investment can off-set income from them all!
All of this equates to about a 20% internal rate of return on your money. All without the crazy ups and down of the market
Dave Anthony, CFP®, RMA®