Tax Incentives of Investing in Oil Projects

 The US Government Wants To Give You An Investment Break


Oil project investments can prove highly beneficial for investors with potential for growing returns as well as the tax benefits granted by the United States Government. The government wants to increase production and reduce reliance on imports from other countries. Tax incentives granted by the government can result in a several tax minimization strategies for savvy investors.


Oil and gas investments carry some risk so investors are advised to diversify investments with other assets. At the same time, gains from those assets can be offset by the advantages of investing in oil development.

Oil Investment Tax Deduction Options

As an oil investor you can experience many tax advantages through investments in oil production:  

Tangible Drilling Costs Deductions

The costs of drilling for production and other tangible costs need to be deducted over a 7-year period. However, investors enjoy a 100% deduction for these costs.

Intangible Drilling Costs Deductions

The first year of an oil project all intangible drilling costs, including labor, are a write-off as long as the well is operational by March 31 of the following year. Since intangible costs can amount to 60-80% of the costs of oil well drilling, the deduction can be advantageous for investors. Intangible costs include most expenses except for the tangible cost of equipment. (see above) Expenses like employees, crews, supplies, chemicals, mud drilling, and the like are all included in intangible costs.


Because intangible and tangible costs cover most of the drilling expenses, investors have the possibility of almost all costs of the project deductible. This is true even if the project does not actually produce oil since the deductions are not linked to oil production or performance.

Lease Cost Deductions

An investment in an oil lease rights also provides many tax deductions since most of the costs like accounting, administration, and lease operating expenses are included. As long as these expenses are capitalized and written off via a depletion allowance over the term of the lease, the associated costs are deducted.

Depletion Allowance for Small Producers

This is a tax exemption for small producers and investors that allows 15% of all gross income from oil wells to be excluded from taxation. This tax law was created specifically to encourage oil production and investment. A small producer puts out less than 50,000 barrels of oil a day, or owns fewer than 1,00 barrels of oil a day in order to qualify. The depletion allowance addresses the gradual depletion of oil at a site over time.

Active and Passive Income Deductions

Working interests in oil wells are defined an active income activity for tax purposes. Losses for investors in these fields can be deducted against business income, capital gains, interest income, salary and other active income sources. For investors with a diversified portfolio these losses offer great offset capabilities.

Tax Credits for Marginal Wells

A growing number of marginally producing wells have been capped. The U.S. Government wants to keep remaining “stripper” wells producing even at a marginal rate. So tax credits are granted to a maximum of $9 per day, per well for marginal oil wells. These wells account for up to 25% of crude oil produced in the U.S. Tax credits directly offset taxes owed, so this is one way to reduce overall tax liability.

Enhanced Recovery Credit


The tax benefits and exemptions for enhanced recovery methods of oil extraction have few limits. Over time wells decrease production due to decreased pressure in the well. The government wants to keep those wells productive by encouraging various forms of extraction (enhanced extraction) the government offers a tax credit of 15%. Qualifying enhanced methods include chemical, steam and carbon monoxide methods to attempt to extract more from a well. The only limit is the small producer limit, meaning tax benefits from investing in oil and gas drilling are a great option even for high net worth investors.

Multiple Choice Tax Benefits


These are some of the tax benefits related to direct investment in oil production. Other tax benefits can be obtained through 1031 exchange, mutual fund investing, partnerships and limited partnerships, royalties, interests, stock and ADRs all based on oil production.


Investors looking to apply exemptions and credits to overall tax liability can experience great benefits from oil production investments. Working with your tax professional you can create a strategy to minimize overall tax liability by using the U.S. Government tax law benefits of investing in oil projects. No other investment type offers the diversity of tax benefits.