Exploring for a year-end tax deduction? Sinking some dollars into an oil and natural gas drilling deal can be risky. But such investments can offer robust returns as well as write-offs.
One benefit provided by the tax code is an upfront tax deduction. "Often, a large portion of your investments may be deducted in the first year," said Ronald Rutherford, a certified financial planner in New York. In other types of business, more of the costs must be written off over long time periods.
The amount you can deduct would vary according to details of the transaction. But suppose you invest $25,000 in a drilling deal this year. Say you get to deduct $18,000 from your 2007 income. In a top 39.6% federal tax bracket, that deduction would save you more than $7,000 in tax payments. State tax deduction might increase your total savings.
Depletion Allowance
If your drilling investments find oil or gas, you may get revenue starting in late 2007 or 2008. Then your taxable income will be reduced by depletion allowance. That's a second tax break to encourage energy exploration. It assumes the well in which you've invested loses value as the energy resource is pumped out. You can treat part of your revenue as a nontaxable refund of your original investments rather than as taxable income. Imagine you're paid $4,000 in 2007 for your 2007 investments. Because of the depletion allowance, you might have to report only, say, $3,000 as taxable income. The exact amount will vary each year, depending on factors such as the amount of oil and gas produced and income reinvested. This shelter can go on as long as the oil and gas keeps flowing.
A third reason to consider making this type of investment is for the sake of diversifying your portfolio. When stocks or bonds are weak, oil and natural gas prices may rise. Despite these benefits, there are risks. Mainly, the driller might not discover enough oil and gas.
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