What if the money you’re about to send to the IRS could instead fund an income-producing investment? That’s exactly what oil and gas investing makes possible.

Thanks to IRS Code Section 263(c), investors can claim massive upfront deductions while also generating long-term cash flow from production. This makes oil and gas one of the few strategies that can meaningfully lower your current tax bill while building future income.

How the Oil and Gas Tax Strategy Works

Oil and gas investing allows you to take intangible drilling costs (IDCs) as a deduction in the same year you invest. Under Section 263(c), up to 85% of your investment can be written off immediately. That means if you invest $100,000, you could potentially deduct $85,000 against your active income in the year of investment.

Unlike many tax strategies that only apply to passive income, these deductions offset active income. 

Cash Flow on Top of Deductions

The tax write-off is just one part of the benefit. Oil and gas investments also produce cash flow through the sale of oil and natural gas. Investors can see returns within months of drilling, creating a unique combination: front-loaded tax savings with long-term income potential.

Who This Strategy Is For

This makes the most sense for:

• High-income earners and business owners with $100K+ to invest
  
  
• Investors looking for both immediate tax relief and ongoing cash flow
  
  
• Those seeking diversification outside of traditional markets
  
  

Because of the large upfront deductions, oil and gas can significantly reduce tax liability in the year of investment, freeing up more cash for reinvestment.

Compliance and Risks to Consider

Like any tax strategy, oil and gas investing comes with rules and risks. Investors must work with credible operators to ensure compliance with IRS guidelines. Drilling is inherently risky, and not every well produces as expected.

Key considerations include:

• Partnering with an experienced operator
  
  
• Understanding that drilling results can vary
  
  
• Balancing the tax benefits with investment risk
  
  

Bottom Line

Oil and gas is one of the few strategies that lets you reduce your tax bill today while building long-term wealth tomorrow. By leveraging Section 263(c), you can transform dollars that would have gone to the IRS into a cash-flowing asset.

Listen to the full episode now.

Transcript

[00:00:00] Mike: What if I told you there's an investment strategy that can not only provide cash flow, but also potentially wipes out your tax liability in the same year? Today we're diving into one of the most overlooked and powerful tools in the tax strategy playbook. Oil and gas investing. Whether you're a high income earner or a business owner looking for a legal way to dramatically reduce your taxable income, this episode could change the way you think about investing.

[00:00:41] Joining me is a special guest from US Energy to break it all down from the upfront tax benefits of drilling funds to how this can supercharge your QBI planning. We're gonna go deep on what your cashflow could look like, how the IRS views these types of investments and the real risks you need to understand before diving in.

[00:00:58] So, Nick, welcome to the show. [00:01:00] Yeah. Mike, thanks for having me. Appreciate being here. Yeah, super excited for this one. I had Nick on a private event for our Taxon members about a month ago and just talked about some really good stuff, and it was super valuable. So I wanted to talk to Nick. I said, we need to get you onto our podcast to give it Lisa, a high level overview of this strategy, just because I think there's so many people that.

[00:01:19] Either don't know about oil and gas investing or just don't quite understand it. And I think that the way that you guys talk about it, the way that you guys explain it is super helpful. So, Nick, just to kinda get started, give us a, a little background about US Energy and kinda where your guys' focus is in the industry.

US Energy Background

[00:01:36] Guest: Yeah, so I've, I've had the pleasure of working with US Energy for the last 14 years and, my experience, I've worked with thousands of advisors, clients, CPAs, on educating them on the benefits of utilizing oil and gas investments from a tax planning and cash flow perspective. So US Energy been around a long time.

[00:01:53] We're incorporated back in 1980, so well over 45 years experience in offering these type of investment vehicles. [00:02:00] To the community. We have drilled assets in over 13 different states, and even two provinces in Canada. Have raised and deployed roughly four and a half billion dollars of capital. So we're the largest syndicated oil and gas sponsor in the United States.

[00:02:13] And typically what we do is we operate in the, for at least for the last five years, specifically in the Permian Basin in West Texas. So we're unique in that we are a vertically integrated oil and gas company. So I'm one of three directors of business development. The majority of our staff is engineers, geologist, geophysicist more boots on the ground, guys headquartered in Fort Worth, Texas.

[00:02:36] But we're a little bit different than most where we're not only a great operator, but we're also a great structural syndicator. And what that means is that we're great about constructing investment vehicles that can take advantage of the oil and gas tax code. Create these unique cash flow opportunities for clients.

[00:02:54] So with traditional drilling funds, like we offer all of that is in the West Texas Permian Basin region, right on [00:03:00] the border of New Mexico and Texas. Oil and gas obviously may not be known by too many, but if you think about it from a macro perspective, right? The United States produces roughly 13.3.

[00:03:12] Million barrels per day. Eight and a half of that's coming from the Permian Basin alone. Right. So we have the luxury of being in the hottest shell play working with major publicly traded oil and gas companies. These are household names that we're joint venture partnered with. You're talking about Exxon Shell, Occidental.

[00:03:30] So we've been able to aggregate these partnerships and co-invest capital into the Permian Basin region. Focus on drilling brand new oil and gas wells.

Focus on Drilling Fund

[00:03:38] Mike: Yeah. That's great. And so, I know you got many different types of products based on kind of the needs of the investor and you know, where their situation is.

[00:03:45] But the one that I wanna focus on just 'cause you know, we have a short timeframe here is, is specifically your drilling fund. So talk to us a little bit, because a lot of people listen to us. So saying oil, gas, okay. But what is the tax benefits of why can it be not only an investment play, but [00:04:00] also a, a tax play?

[00:04:01] Talk a little bit about the tax benefits specifically for your drilling fund. Yeah,

Tax Benefits: IRS Code 263(c) and IDCs

[00:04:06] Guest: so it's been a part of the tax code for a long, long time, longer than I've been alive, right? So it was incorporated back in 1914. Specific tax code is IRS code 2 63 C. And so the government, obviously there's a benefit of promoting domestic oil and gas drilling, right?

[00:04:23] We want to be reliant on our own energy needs, and we don't want to be overly reliant on foreign nations for energy needs, right? So in order to kind of boost activity funding this IRS code came into play again, IRS code 2 63 C, and what that states is that an investor that invests into a, a direct energy partnership, right, is able to take a tax deduction.

[00:04:46] Based on that fund's share of intangible drilling costs. So you'll see the acronym IDCs if you do research, but it's intangible drilling costs. These are the costs of drilling a well that don't have any salvage value or depreciation schedule tied to [00:05:00] it. Right? So you're talking about the cost of hydraulically fracturing, the, well, the building of the roads.

[00:05:05] The paying of the wages. In my 14 years, the lowest I've ever seen that deduction is 85% for US energy, and the highest I've seen it is 90. Right? So it's a great strategy for clients looking to reduce active income, and it could go against W2 10 99 K one capital, again, doesn't matter, but let's just say on a hundred thousand dollars investment made.

[00:05:29] For 2025, you're receiving a $90,000 ordinary income deduction, right? That can apply to both federal and states. So ultimately it's doing what we all wanna do, right? We wanna keep more money of our hard-earned money in our pocket, have it work for us, as opposed to, you know, sending more money over the wall's, uncle Sam.

Tangible Costs, Depreciation, and Depletion

[00:05:48] Mike: Yeah, that makes sense. So we have the IDCs, and so like you said, about 85 to 90% of your investment. You get that as a deduction in year one, that can offset ordinary income, which I think is something that's really [00:06:00] important to put on is a lot of times we talk tax strategy and we say, well, you offset business income or it offsets passive income or different things.

[00:06:07] Very rarely do we find opportunities that will, can offset W2 income. Business income can offset anything as far as an income level. And so that's super powerful with with the IDCs. But there's also some additional benefits where you have tangible drilling costs, so not the intangible, the tangible drilling costs, and then a depletion allowance.

[00:06:25] Talk to us a little bit about how those two work from a, a tax play as well.

[00:06:29] Guest: Yeah, so immediately upfront, like for this calendar year, the IDCs, you're gonna come into play, right? That's where you're gonna see that 85 and 90% deduction. Now the other side of the, the tangible cost, right? Those are gonna have a depreciation schedule tied to it, which will help shelter income as revenue is generated from the assets, right?

[00:06:47] So an investment made this year you can invest either today or all the way up to December 31st, and that deduction's going to apply. For 2025 income, starting in the first quarter of 26 is when the cashflow phase [00:07:00] starts. We're typically drilling 150 to 200 wells in the partnership. It's very large, around 650 million.

[00:07:06] The cashflow begins in Q1, and then that's where you're gonna see some of the other advantages of oil and gas, which you mentioned. Depreciation and depletion, right? So. If I generate, let's say, $10,000 of income from the fund next year, I'm not having to pay taxes on that full $10,000 of income earned, right?

[00:07:25] You get to take advantage of depreciation and also the depletion allowance, which will shelter a lot of that income, right? On my personal K ones, when I see it. I'm usually seeing around 20 to 25% of my income every single year sheltered from taxes. So I earn 10 grand, but I'm only having to pay taxes on $7,500.

[00:07:46] it's that unicorn, right? It's that I get the big deduction in tax savings upfront, but I'm also creating a. A long-term tax efficient income stream over the life of the fund.

Alternative to Buying Equipment for Deductions

[00:07:56] Mike: Yeah. You know, one thing that, I love about this is that [00:08:00] when I talk to small business owners that do tax planning or they first come to tax, EL never really have done tax planning before, but they think they've done tax planning, they say, well, yeah, I see my accountant and you know, they say go buy a new truck or go buy a new piece of equipment at the end of the year.

[00:08:12] And you know why that creates a tax deduction. It's. Maybe a vehicle that you don't need, you didn't need, but you just got it for that tax deduction. And essentially you just got a discount on, on that piece of piece of property that you bought, but you didn't actually need it. And I think that that is such a bad tax play because it's something that you don't need, you just spent money on and all you got was discount on it.

[00:08:32] I'm sure you saved taxes, and that's just a discount on that. But this, I like to compare it as a really good alternative that's. So much better than just buying something you don't need because not only are you getting maybe not a hundred percent, you're getting 85 to 90%, which is a large amount in that year one.

[00:08:48] But now you have an asset that is going to continue to produce income and will produce income down the road and continue to grow. And so instead of having a depreciating vehicle, you're getting essentially the same thing out of it, but now it's an [00:09:00] appreciating asset. And so, yep. Let's run through the numbers to understand.

Example Numbers and Cash Flow Timeline

[00:09:04] I mean, obviously this is all hypothetical and we can't guarantee results and things like that, but I think it's good to kind of run through numbers historically on what your funds have done. So let's just say we invest a hundred thousand dollars into your drilling fund. What does that kind of, what does the cash flow in return on that a hundred thousand dollars look like, including kind of the tax savings from it as well?

Returns and Year-One Tax Savings

[00:10:12] Guest: Yeah, so a hundred thousand dollars investment this year is gonna get you, let's say, a $90,000 ordinary income deduction. Now, let's make the assumption, right, 'cause it's, it can vary based on your federal and your state effective tax rate, your actual tax savings. But for this example, let's say you're at a, you're like me and I live in New York, you're at a 50% tax rate.

[00:10:32] So based on a $100,000 investment, $90,000 loss multiplied by 50%, I'm saving $45,000 in taxes. Based on a $100,000 investment, right? That's an immediate return to me, where I can then use that to buy that new truck, right? The tax savings, or I can use that to reinvest. Into my business, into my market and keep that growing for me and working for me.

[00:10:56] Now, when the cashflow phase begins, starting in the first quarter of [00:11:00] 26 when we launched these investments, right, looking from a past performance and then also a future. Performance. We try to structure these. So a 100% return of capital is achieved within about a four to a five year period, right? So on average, we're trying to target between 20 to 25% a year in cash flow during that four to five year, first four to five year period.

[00:11:23] Mike: Okay.

[00:11:23] Guest: Now the nature of an oil and gas well is that it tends to deplete. That's part of the reason why you get a depletion allowance. So after year five, your post flush production starts to come in where you start to see cash flow taper off all the way until there's nothing left in the ground. By right around year 10, over that 10 year life, you're usually seeing based on experience, a one and a half to a two times return on your investment.

[00:11:47] And that's. Not including the tax savings you received in the first year, right, so it's a very quick return of capital, but a hundred grand, 45,000 saved in the first year. I've received a hundred grand back in cash flow in the [00:12:00] first four to five years. Over 10 years I've received 200,000 back in cash flow, plus the 45 grand in tax savings.

[00:12:07] Mike: Yeah, that makes sense. And, and as you kind of mentioned some of that, those funds that you're saving. So if, if you turn a hundred thousand into 200 over the course of 10 years not all of that would be taxable because you have some of the depletion allowances and things like that as well, correct. You got

[00:12:21] Guest: it.

[00:12:21] And there's ways to juice up your return too. I try to encourage investors to, to do this because most clients will use the tax savings and go on a vacation, right? And you can do that. Don't get me wrong. I'm not telling you what to do with your money, but if you're looking to juice up your rate of return from this investment, take those tax savings, invest that back into the market and back into your business, right?

[00:12:41] That 45 grand you save is actually gonna grow over time in terms of value. And as these distributions start to come in. Starting in the first quarter have them sent back to your brokerage account, right? So then you can then reallocate those to the same thing, other investments that you'd be may be making.

[00:12:57] So I always encourage investors to do that because I [00:13:00] think it's a better way to use the oil and gas code. And actually increase your rate of return from the investment.

Risks: Tax vs Investment

[00:13:06] Mike: Yeah. Makes sense. So, you know, whenever we're putting money into a different opportunity I think risk comes up. And specifically in my realm talking about tax strategies, tax different things.

[00:13:18] There's what I call an investment type risk and then a tax risk. And so I want to touch on both of those. But let's talk about the tax risk. First because some strategies we talk to that say it's black and white in the tax code, but if it's not done correctly, if we misuse it, we abuse it, we can abuse it and make something that was legal illegal.

[00:13:36] And I, I always say it can be something as simple as a home office deduction. Everybody can and should be, most people should be using it. But you can say that. 95% of your homes at your home office, that's clearly not gonna be legitimate and you're taking an a, a legal strategy and making it illegal.

[00:13:53] So let's talk about the tax risks from oil and gas. You mentioned this is in the tax code for a while. So when you look at it from a [00:14:00] tax standpoint, do you see any kind of specific tax risk or something that other people in the industry maybe don't do correctly that that kind of creates a tax risk?

Tax Risk and Limitations: EBL and AMTI

[00:14:10] Guest: In terms of audit risk, I think that's always jumping to CPAs and clients' mind first and foremost, right? What, what is my risk of an additional audit? And for this type of investment, it's built into the tax code. There is no audit risk. There's, it's really just black and white. You invest into a drilling fund partnership, you're able to take a deduction against.

[00:14:28] Your active income through the use of intangible drilling costs. Now, there's certain limitations that I don't think a lot of sponsors are transparent about or maybe not necessarily even know. Right? And some of those. Things to be aware of is that there are limitations for how much you can deduct, right?

[00:14:46] You're not gonna take your income down to zero through an intangible drilling cost type of a fund. So there's two that I like to really point out there. One is excess business loss limitations, right? You probably run into it quite a bit. [00:15:00] If you're fully W2, you know the max that you can deduct based on what they call it, EBL, but excess business loss limitations is around 500,000 for a joint filer.

[00:15:10] So if you're making one to $2 million, you can't take more than 500,000 if you fall into that realm. So that's point number one. The one I run into most often is a MT limitations, right? Alternative, minimum taxable income. So, you are gonna able, you're able to deduct up to 40% of your A MTI, right?

[00:15:33] So that's located on form 62 51. So if your A MTI is, let's say $1 million, right? You can only deduct up to 400,000 for the current tax year. Now, if you end up going above that a little bit or even quite a bit, you don't lose the rest of it. The only thing is, is that the rest that you can't take is amortized over the next five years, so it's best practice to just take up to [00:16:00] that amount.

[00:16:01] Then if you need to do it again next year, do another investment next year. Maximize the full amount that you can take in any given tax year.

Investment Risk: General Partner Status and Insurance

[00:16:09] Mike: Yeah, no, that makes sense. And let's flip aside and look at an investment side risk, because I think that this comes into play for, for a couple different things.

[00:16:17] One, in order for this IDC deduction to be able to offset your ordinary income, W2 income, business income, those types of things, you have to be considered a, a general partner. And so talk to us a little bit about what that means and what the risks associated with that are for investor that is considered a general partner.

[00:16:37] Guest: So that's the way we can take it against active deduction, right? Is that quote general partner liability. Trust me this isn't the same thing as solar where you have to work so many hours to be able to take it. This, this is just, you're coming as a general partner and then you're able to take that active income deduction.

[00:16:52] So when you look at the definition of a general partner, it can be a little bit concerning, right? Because what that means is technically you're at risk for [00:17:00] more than your invested amount. Now this is where it becomes really, really important to work with a sponsor that's been one doing it a long time, that has a long-term track record that goes through a due diligence cycle every single year with major broker dealer community for the vetting process, right?

[00:17:18] And so for us energy and the syndicated oil and gas space, meaning that they go through due diligence, there's never been a case law in US history where a general partner was asked to contribute. More than they invested right? It happens on the private side quite a bit, but not on the syndicated side.

[00:17:34] Like with what we do, you're only a general partner for about six to nine months, right? As soon as all the wells are drilled and completed, you're automatically converted to a limited partner for liability purposes. And during that six to nine month window we carry numbers of different layers of insurance, right?

[00:17:53] So we have a $50 million blanket policy through Chubb. That protects investors. We also have [00:18:00] subcontractor drilling insurance working with Exxon Shell and Occidental which is typically around 180 million. And then we put pledge the entirety of our company and our assets in front of clients. So in aggregate, during that six to nine month period, you have close to half a billion dollars of insurance that cover you for liability purposes.

[00:18:18] So now again, that risk is. There, but it's quote unquote theoretical If you work with the right sponsor that has the right protections in place.

Investment Approach: Drilling Types and Success Rate

[00:18:28] Mike: And then let's also talk about the investment risk in, some of the things that you guys do to help protect that. Because, I think that when people get a bad taste from oil and gas, oftentimes it's horror stories.

[00:18:40] I invested in this project and the money disappeared. Never saw it again. Never talked to the person again. And so obviously that's scary. And then people. Tend to feed off a horror story. So talk to us a little bit about the investment risk because this isn't just a tax play. I, I look at this as both a tax and an investment play.

[00:18:57] Obviously I talk about the tax side, but, you [00:19:00] know, talk to us a little bit about the investment side risk and, and some of the things that you guys put into play for that.

[00:19:05] Guest: So I mean, oil and gas, it does get a bad rap for the old eighties and nineties. Right. Well, things have changed quite a bit and some of the leading questions that you wanna ask a investment company that you're maybe potentially wanting to work with, I think the first thing you wanna ask them is what type of drilling that they're doing.

[00:19:21] Right? Because there's different types, which I'll carry different risk sets, right? There's a lot of companies out there that like to do exploratory drilling, which is synonymous with wildcatting, you know, and that would be something like, Hey, throw a dart at this map. Wherever that thing hits, we're gonna go and drill those wells.

[00:19:37] Well, nine and a half outta 10 times. You're not gonna find any oil in that type of vehicles. that one time you do. That's where you hear clients receiving generational wealth. That tends to be inherently a. Too risky for what our investors look for. There's step out drilling, which would be a little bit better of a success rate, but you're operating on the outskirts of the basin.

[00:19:58] Again, a little [00:20:00] bit too risky for what our investors look for. Everything that we do is what's called developmental drilling. So you're operating in a proven area of proven production. There are thousands of wells surrounding your location, and essentially what you're doing is creating a very tight standard deviation on what to expect from a cash flow perspective.

[00:20:19] Kind of putting numbers behind it. Since 2009 when horizontal drilling came in as a new technology we have a 100% success rate on every single well that we drill, right? So we're trying to take the risk of the drilling process out. Again, our, our goal is to provide these tax savings and tax deductions, but then also more importantly, predictable and repeatable cash flow.

Hedging and Commodity Price Risk

[00:20:40] Now, the one risk on the investment side, is, you can control it, but it's not under your control, always is commodity price fluctuation. Because your returns are based on two different things. You have, how many barrels of oil did you produce for the quarter, which we have a really good feeling based on the type of drilling we're doing.

[00:20:59] The one thing that we [00:21:00] don't control fully is at what price are we realizing those barrels of oil at? Right? So commodity price fluctuations can affect the overall rate of return for these investments. And so what we started to do. About a decade ago is implement hedging within these portfolios, right?

[00:21:16] Try to take away some of that downside risk by implementing those hedges. And so essentially what we're doing is for 50% of our production. We're creating a ceiling and a floor, right? So let's say the ceiling on our hedge is $80 a barrel, and then the floor is, let's say 65. If prices trade within that range, WTI, we're gonna get paid at that price.

[00:21:37] Well, let's say we see another COVID situation and prices fall below 65, well. We can enact our swap with the bank and 50% of our production will still be paid at $65, right? So what you're doing is you're protecting against downside risk. And we found that that is the best way to do things because if we do what you sit, do what [00:22:00] we say we're going to do provide clients with tax deductions, tax savings, and predictable repeatable cash flow

QBI Planning Strategy

[00:22:06] Mike: yeah. No, that makes sense. And so, with that being said, I wanna talk about a strategy that, that I really like to use oil and gas with. And this is specific to, to business owners, but talk to us a little bit about how to use an oil and gas investment around planning for qualified business income or, or QBI.

[00:22:24] Guest: so you're, you're really targeting those specialized service trader business, right? Yep. So your doctors, your dentists, your lawyers, your accountants, if you fall into that realm. There's certain income limitations that you get hit with where that 20% qualified business income deduction starts to be phased out, right?

[00:22:41] So for joint filers, that number is 384,000, and then it's fully phased out at $484,000 of income, right? So if you're at that 500, 600, $700,000 of income, there are ways that you can reduce your a GI to phase that back in. [00:23:00] On top of maximizing retirement accounts and other planning you're doing with Mike.

[00:23:04] Oil and gas is a great way to, to utilize that, right? So for example, if I'm a client making $600,000 a year, right? I'm phased out of being able to take that 20% deduction against business income. What can I do that same year to help reduce my a GI and phase that back in? I can make a $100,000 or 150,000 investment in oil and gas.

[00:23:26] Now my a GI is going from six 50 down to around 450,000. Right. You're reducing that a GI down. So on top of the federal and the state savings that you're receiving, you are now adding back in that qualified business income deduction. I dealt with a attorney last year on a $150,000 investment. He was, ended up saving around 75% in taxes just from that strategy alone.

Leverage Example and QBI Stack

[00:23:52] Mike: Yeah. You know, when we talk about advanced strategies, which I would place oil and gas into, we talk about using leverage on different things. Mm-hmm. But I was [00:24:00] running the numbers for someone the other day that was making $500,000 phased outta the QBI I deduction. Mm-hmm. By making a hundred thousand dollars deduction that opened up.

[00:24:09] The full QBI deduction for them, which allowed them to now get an additional a hundred thousand dollars deduction that they wouldn't have got. So they invested a hundred thousand dollars in oil and gas. They're getting a hundred thousand dollars deduction from QBI. Plus the additional 90% of the of the oil and gas investment.

[00:24:28] So they're actually getting $190,000 deduction that they wouldn't have gotten without that investment. And so I think that that's a way that you can definitely play that game where you can see some bigger leverage and even some bigger tax returns simply by moving with different brackets and different types of limitations that you might be in.

Policy Watch and Closing Setup

[00:24:46] Guest: Yeah, I think that's fantastic. And it becomes even more important, right? With the big beautiful bill that we're seeing potentially pass here soon, right? The QBI deduction limitations are, are actually going up. They're talking about making it 23%, right? So there's additional [00:25:00] savings to be had potentially on a go forward basis.

[00:25:02] It's such a great planning tool for individuals that are falling in that bucket.

Closing and CTA

[00:25:07] Mike: Yeah. Yeah, that makes so much sense. And you know, for those of you that say, okay, this sounds great, I just wanna learn more, we talk. We had Nick on for our tax home community, and we kind of deep dove into this topic even more.

[00:25:17] So there you have it, a strategy that could produce returns and offset your taxes. That's the kind of two for one deal. Every smart investor should be exploring if the idea of putting money to work while potentially knocking down your tax bill sounds intriguing. This is your sign to dig deeper. As always, talk to your own tax professional, but don't ignore this kind of opportunity.

[00:25:37] If this fits your profile, shoot us an email at [email protected] and we can introduce you to our partner to learn more about it. Hit that like button and subscribe if you want more tax savings strategies like this, and don't forget to share with a friend and leave a review as it helps us keep doing what we're doing here.

[00:25:52] Nick, thanks for coming on.

[00:25:54] Guest: Yeah, thanks for having me, guys. Appreciate

[00:25:55] Mike: it. Awesome, and for everyone else, I'll see you on the next one.