Working Interest & Taxes
Learn about the tax implications of ownership in oil and gas wells and the various working interest tax deductions.
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.
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.
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.
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.
What is an authority for expenditure (AFE)?
An AFE is a document provided by the operator (drilling company) that outlines the estimated costs for a working interest project. This document is important, because it serves as a guideline for economic assumptions and modeling. There are two types of costs outlined in an AFE: tangible drilling costs and intangible drilling costs.
TANGIBLE DRILLING COSTS (TDCs)
Expenses associated with tangible assets such as equipment and supplies used for drilling and completing a well.
INTANGIBLE DRILLING COSTS (IDCs)
Expenses not associated with tangible assets such as services, labor, and non-salvageable materials.
TANGIBLE DRILLING COSTS (TDCs)
Expenses associated with tangible assets such as equipment and supplies used for drilling and completing a well.
INTANGIBLE DRILLING COSTS (IDCs)
Expenses not associated with tangible assets such as services, labor, and non-salvageable materials.
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:
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.
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.
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.
Ultimate Guide to Oil & Gas Investing
Fill out the form to receive a free eBook on oil and gas investing.
Qualified investors will receive: