Tax advantaged oil and gas investments? Be very skeptical
Posted January 15, 2013on:
In the last month alone, I’ve gotten calls from two clients asking me if they should invest in tax advantaged oil and gas investments being pitched to them? Both of these clients are physicians.
The pitch is that oil and gas investments are like IRA accounts, but without the contribution limit. Whatever amount you invest can be written off right away.
The pitch is quite alluring to high-income professionals like physicians who are facing higher taxation. But it sounds too good to be true, so I did a study.
It turns out what is being pitched as “tax advantaged” is in fact the riskiest part of an oil and gas investment.
A full 75% to 85% of oil and gas investment goes to what is called “intangible drilling costs.” These costs are 100% deductible because once the money is spent, it is gone regardless of whether the well is dry or wet.
The rest is so-called “tangible drilling costs,” such as drilling equipment that can be depreciated over seven years.
There is no tax advantage to an oil and gas business relative to other businesses. It’s just that other businesses typically don’t burn through all their investment in one year for ONE shot at success.
The other problems with these type of investments are asymmetric information and moral hazard. There are economic terms to describe the fact that the two sides in a deal often have different knowledge levels, and the side with more knowledge will take advantage of the side with less knowledge.
To put it in layman’s term, if the well to be drilled is a sure bet, do you think it needs to be pitched as an investment option to physicians who have no clue about the oil industry?
Use some common sense. If something needs to be pitched by a salesman – be it a life insurance policy or an oil and gas investment, it’s probably not worth buying.
But then, common sense is the least common of all senses when it comes to investment. That’s why I still have a job.
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