Oil & Gas Working Interests

A direct working interest in oil and gas drilling allows the investor to deduct intangible drilling costs (IDCs), typically 60% to 85% of the investment, in the year the money is spent. Uniquely, a working interest held without limited liability is exempt from the passive loss rules, so the deduction can offset W-2 and other active income. Tangible costs are depreciated, and once wells produce, percentage depletion shelters a portion of the income stream.

The part that requires adult supervision

• You are drilling wells. Dry holes, commodity price swings, and operator execution risk are the dominant drivers of outcome. A 37% deduction does not rescue a 100% loss.
• Unlimited liability. The passive-loss exemption requires a general partner style interest. That means liability exposure that has to be managed with insurance and structure.
• Recapture. IDC deductions are recaptured as ordinary income on sale, limited to the gain. The deduction is partly a timing benefit, not a permanent one, unless held long term.
• AMT and reporting. Excess IDCs can be an alternative minimum tax preference item, and K-1 reporting adds filing complexity.

How we approach it

We review the sponsor's historical well results, fee load, and alignment before the tax math enters the discussion. Our working assumption is that most retail-distributed drilling programs are priced so that the sponsor captures the tax benefit. The programs worth doing are the minority, and position sizing is capped accordingly.