Oil & Gas Tax Strategies

Explore oil & gas and mineral rights strategies designed to provide potential tax savings, steady cash flow, and long-term wealth.

Learn how working interests may offer significant deductions, depletion benefits, and generational income by contacting our team!

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Oil & Gas Working Interest Tax Treatment

One of the most attractive aspects of ownership in oil and gas is the range of tax incentives available. These benefits are designed to encourage domestic energy production and reduce dependency on foreign oil. Read on to learn some of the ways owning working interest can affect tax planning.

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Depletion Deductions

Section 611 of the IRS Code allows for a deduction in computing taxable income for the depletion of oil and gas wells. This deduction is intended to account for the reduction in the wells’ productive capacity over time.

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Intangible Drilling Cost Deductions

Intangible drilling costs typically encompass 65-80% of the total cost of drilling a well. Under Section 263(c), taxpayers can elect to either deduct these costs in the year they are incurred or capitalize and amortize them over 60 months.

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Tangible Drilling Cost Deductions

Tangible drilling costs are also deductible, but are generally capitalized and depreciated over their useful life under Section 167. This time period is typically 5-7 years.

a pie chart comparing working interest, royalty interest, and overriding royalty interest.

Risks & potential rewards of working interest

Working interest ownership can present potentially significant economic opportunity, but also presents a higher degree of risk than other oil & gas asset classes. If costs exceed those outlined in the AFE, the WI participant can be subject to paying their share of the overruns.

Looking at the chart to the right, WI participants receive a proportionately higher share of the revenue than royalty owners (mineral rights owners). WI owners receive 75% to 87.5% of the revenue from the sale of oil & gas, depending on various factors such as lease terms. Read on for a more detailed description of each of the interest types shown on the chart.

Types of Oil & Gas Interests:

RI

ROYALTY INTEREST

Royalty interest is a type of ownership interest where the holder is entitled to a percentage of the revenue from oil and gas production—without having to pay for drilling, operating, or production costs.

  • This interest is typically retained by the original landowner or mineral rights holder when leasing the land to an oil and gas company.
  • Usually expressed as a fraction (e.g., 1/8 or 12.5%) of the gross production revenue.
  • Offers a passive income stream tied directly to the volume and price of production.
WI

WORKING INTEREST

A working interest in oil and gas investments is an ownership stake that gives the holder the right to explore, drill, and produce oil and gas from a property—but also requires them to pay a proportional share of the costs.

  • Costs include expenses for drilling, operating, and maintaining the well.
  • In return, the working interest owner receives a share of the production revenue after royalties and expenses are paid.
  • While it carries more risk than a royalty interest, it also offers greater potential returns.
ORRI

OVERRIDING ROYALTY INTEREST

An overriding royalty interest (ORRI) is a non-ownership interest in oil and gas production that grants the holder a percentage of the revenue from production, free of production and operating costs.

  • Unlike a standard royalty interest, an ORRI is carved out of a working interest and typically exists only for the life of the lease.
  • It does not include rights to the minerals themselves and expires when the underlying lease ends.
  • ORRIs are often used as compensation for parties involved in facilitating a lease or drilling deal.