Oil & Gas Asset Acquisition & Management

Oil and gas direct investing offers many tax advantages that can help greatly enhance the economics of an investment. The following information and Internet URL are provided for your convenience and should not be construed as tax advice from Eagle. It is the responsibility of each PARTNER to investigate the tax consequences, under the laws of pertinent jurisdictions, of his or her investment in the FUND. THE ANALYSIS HEREIN IS NOT INTENDED AS A SUBSTITUTE FOR CAREFUL TAX PLANNING. ACCORDINGLY, EACH PROSPECTIVE INVESTOR IS URGED TO CONSULT WITH HIS OWN PERSONAL TAX ADVISOR CONCERNING (i) THE APPLICABILITY TO AND EFFECT ON HIM OF THE UNITED STATES INCOME TAX LAWS AND THEIR ADMINISTRATION, AND (ii) THE APPLICABILITY TO AND EFFECT ON HIM OF STATE, LOCAL AND FOREIGN TAX LAWS AND THEIR ADMINISTRATION. NO LAW FIRM OR ACCOUNTING FIRM HAS PROVIDED OR OTHERWISE Rendered an opinion on the FEDERAL, state, local or foreign tax consequences of an investment in THE FUND. The Online U.S. Tax Code may be accessed at http://www.fourmilab.ch/ustax/ustax.html

Intangible Drilling Cost Tax Deduction

The intangible expenditures of drilling (labor, chemicals, mud, grease, etc.) are usually about (65 to 80%) of the cost of drilling an oil and/or gas well. These expenditures are considered “Intangible Drilling Cost (IDC)”, which may be 100% deductible during the first year for certain qualifying investors. For example, a $100,000 investment could yield up to $80,000 in IDC tax deductions during the first year of the venture. These deductions are generally available in the year the money was invested, even if the well does not start drilling until March 31 of the year following the contribution of capital. (See Section 263 of the Tax Code.)

Tangible Drilling Cost Tax Deduction

The total amount of the investment allocated to the equipment “Tangible Drilling Costs (TDC)” is 100% tax deductible. In the example above, the remaining tangible costs ($20,000) may be deducted as depreciation over a seven-year period. (See Section 263 of the Tax Code.)

Active vs. Passive Income

The Tax Reform Act of 1986 introduced into the Tax Code the concepts of “Passive” income and “Active” income. The Act prohibits the offsetting of losses from Passive activities against income from Active businesses. The Tax Code specifically states that a Working Interest in an oil and gas well is not a “Passive” Activity. (See Section 469(c)(3) of the Tax Code). As such, if the Fund owns one or more working interests in one or more oil or gas leases at any time during a tax year, individual investors that own general partnership interests directly or through entities that do not limit their liabilities with respect to their units should not be subject to the passive activity loss rules with respect to such working interests for the tax year. As a result, such investors should be able to utilize losses from the Fund from such working interests to offset future income from the Fund and their other so-called “active income” (e.g., salary) and “portfolio income” (e.g., dividends, interest and royalties not derived in the active conduct of a trade or business).

Small Producers Tax Exemption

The 1990 Tax Act provided some special tax advantages for small companies and individuals. This tax incentive, known as the “Percentage Depletion Allowance”, is specifically intended to encourage participation in oil and gas drilling. This tax benefit is not available to large oil companies, retail petroleum marketers, or refiners that process more than 50,000 barrels per day. It is also not available for entities owning more than 1,000 barrels of oil (or 6,000,000 cubic feet of gas) average daily production. The “Small Producers Exemption” allows 15% of the Gross Income (not Net Income) from an oil and gas producing property to be tax-free.

Lease Costs

Lease costs (purchase of leases, minerals, etc.), sales expenses, legal expenses, administrative accounting, and Lease Operating Costs (LOC) are also 100% tax deductible through cost depletion.

There are significant risks associated with oil and gas investments. One of the biggest risks is the fact that commodities pricing can be volatile. Cash flow potential varies according to two main variables: the amount of gas or oil that is produced and sold (if any) and the price that is received for the gas or oil. Both of these variables can fluctuate based on a range of different factors; for example, the price of oil can rise or fall dramatically due to political or economic issues, or even due to the weather.

Gas and oil wells are also depleting assets. The typical production life of an oil well could span between up to twenty and thirty years. Nevertheless, dry holes are possible and returns can decline after the first couple of years. Sometimes the property or wells are made ‘for sale’ a few years down the line, other times they might not be. If there is a proposed exit strategy for the investment that you are considering, it is important that you fully understand it.

As a working interest owner in the various properties in which it invests, the Fund is liable for the debts and obligations to third parties incurred by the operator in conducting operations on an oil and gas lease to the extent of their proportionate working interests. In general, the liability of an owner of a fractional undivided working interest includes contract liability, tort liability, special statutory liability and tax liability.

External political and external events also affect gas and oil availability and pricing. There are varying levels of risk among energy choices. You should consider all energy choices as high risk but royalty programs generally tend to be more conservative while experimental drilling programs are the most speculative. Drilling operations may also result in a dry hole, in which case all amounts invested in such operations could be lost.

It is important to remember that your risks are directly tied to those of the company that is in charge of managing your investment. You should therefore ensure that you know the history and background of this company and carry out due diligence before you opt to invest

With a focus on delivering both income and growth potential, ENR Income & Development Partnerships may be a smart fit for investors seeking to diversify into domestic energy production.