Frequently Asked Questions
Intangible Drilling Costs are drilling costs associated with oil and gas operations. IDCs include expenditures related to drilling a well. IDCs range from clearing of the ground and surveying work to wages, fuel, repairs, hauling, supplies and other expenses necessary for the drilling of a well. Because these drilling costs have no salvage value and are treated as expenses they can be deducted in the year of investment.
Under the “functional allocation” provisions of the Program, intangible drilling cost will be allocated to the Partnership’s investors, up to 90% of their investment, as allowed by the Internal Revenue Code. The residual balance of the IDC and 100% of the Tangible Costs of the Program shall be allocated to Hard Rock.
Yes, by investing as a general partner in the Program and not holding the partnership interest in an entity that limits liability, you may utilize the IDC deduction as an offset to adjusted gross (taxable) income items, e.g. salary, interest, dividends, rental, etc. Investors can elect to expense and deduct the IDC in the year of investment or; elect to capitalize and amortize over 60 months.
By investing as a limited partner in the Program, your share of the deduction for IDC will most likely be a passive loss that cannot be used to offset adjusted gross income. Because the limited partner does not participate directly in the Program, the limited partner can deduct IDCs only against passive income.
Holders of general partner units will have unlimited liability for the Partnership’s obligations. This means that if insurance proceeds from any source and the partnership’s assets are not sufficient to satisfy a Partnership liability, all the general partners would have liability for those obligations. Hard Rock reduces these risks by maintaining insurance coverage of $15,000,000 and by utilizing sub-contractors who carry both liability and workers’ compensation insurance. Additionally, when all the program wells have been drilled and completed, each general partner unit will be automatically converted to a limited partner unit thus limiting partner liability. The wells are deemed to be completed when production equipment is installed.
If you invest as a limited partner, your liability is limited to your capital contribution to the Partnership. As stated earlier, the use of the IDC deduction from the Program will be a passive loss that cannot offset adjusted gross (taxable) income. As a result, you may not have enough 2013 net passive income from your other investments to offset all of your 2013 passive deduction from IDC. In that event, however, your unused passive loss from IDC may be carried forward indefinitely to offset your passive income in subsequent taxable years.
This is a tax benefit for oil and gas investors, it is a percentage depletion calculated using 15% of the gross production income for the life of the wells. Therefore; this tax benefit allows 15% of the gross income to be tax-free, subject to certain taxable income limitations of the producing well.
Hypothetical IDC Tax Savings
Current deduction for Intangible Drilling and Development Costs (“IDC”) allows tax savings through income tax deductions in the year of investment.
|WITHOUT an Oil & Gas Investment|
|With a $50,000 Oil & Gas Investment|
* This hypothetical tax savings example is an approximate tax savings based upon the assumption that the taxpayer will be taxed at the 2013 Federal and State (WV) income tax rate associated with married taxpayers filing a joint return, utilizing the standard deduction, and two (2) personal exemptions. This calculation assumes no alternative minimum tax (“AMT”). Results are hypothetical and are in no way a guarantee concerning the outcomes of participation in the drilling program or an investor’s tax liability. Individual results will vary.
Allocation and Use of IDC Deductions
Through a “functional allocation” provision in the drilling program the limited partnership investors will be allocated IDCs up to 90% of the invested amount. IDCs consist of those expenditures (i.e. wages, fuel, repairs, hauling, supplies, etc.) incident to and necessary for the drilling of wells and the preparation of wells for production of natural gas or oil that otherwise have no salvage value.
Those investors subject to the passive activity loss rules of Section 469 of the Internal Revenue Code (the “Code”) who elect to purchase as an Investor General Partner and do not otherwise limit their liability, will not be subject to the passive activity loss rules and may use the IDC deduction against active income. Code Section 469(c)(3) and (4).
Percentage Depletion Deduction can be used to partially shelter income from program wells.
Code Sections 613 and 613A provide for a percentage depletion deduction on natural gas and oil income. Investors will generally be entitled to annual percentage depletion deductions at a rate currently established at 15% of all production revenues allocated to them. The percentage depletion deduction is not limited by the amount of the investment and may be used over the life of the well to partially shelter income from the well(s).
This summary does not purport to be a full statement of the federal, West Virginia State, and local income tax implications of investment in the drilling program. Because of the complex nature of tax rules for limited partnerships engaged in oil and gas operations, it is not practicable to present a detailed explanation of the federal, state and local income tax treatment of those businesses and their partners. In addition to those complexities, the consequences of investing in the partnership are not free from doubt and may vary depending upon the individual circumstances of each investor. This analysis is not intended to be a complete description of all federal income tax consequences or a substitute for careful tax planning. All investors should carefully examine the private placement memorandum, as well as all exhibits attached thereto, related to the drilling program. All investors should seek advice based on the investor’s particular circumstances from an independent tax advisor.
THE ADVICE PROVIDED IN THIS DOCUMENT WAS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED BY ANY TAXPAYER, FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON THE TAXPAYER. THIS DOCUMENT WAS WRITTEN TO SUPPORT THE PROMOTION OR MARKETING OF THE PARTNERSHIP UNITS DESCRIBED IN THE PRIVATE PLACEMENT MEMORANDUM. TAXPAYERS SHOULD SEEK ADVICE BASED ON THE TAXPAYER’S PARTICULAR CIRCUMSTANCES FROM AN INDEPENDENT TAX ADVISOR.