Tax Break Basics: Smart Steps for Investing in an Oil or Gas Partnership

As many of you know, I’m an avid student of all things finance. I’m constantly looking for new ways to invest my money and shelter my earnings from the evil clutches of the tax man! Pay attention to an alternative investment below from a loyal reader of So Over This.

You will have to jump through a few hoops in order to qualify for investing in an oil or gas partnership, but the potential advantages and rewards can be worth the effort when you look at some of the enticing tax breaks you might be able to get.

Here is an overview of exactly what an oil and gas limited partnership is and what it offers, plus some insights into the difference between a limited partnership and a master limited partnership, and what type of investor is going to be accepted as a qualifying investor.

What is it?

In simple terms, an oil and gas limited partnership is a private investment that is primarily created to both develop, drill and operate oil and gas wells.

The basic principle when forming a limited partnership is much the same as it would be with creating any limited partnership and the structure is the same. Investors are invited to inject capital into the business required to develop and then operate the business.

In return, they can hope to receive cash distributions during the term of their investment, but with an oil and gas limited partnership, there are some favorable tax benefits available to qualifying investors in addition to the cash distributions.

The normal scenario with a limited partnership is that the sponsor of the project oversees and manages the operation on a daily basis, as well as taking on the designated role as managing general partner of the partnership.

This managing partner, or it could also be an affiliated company, is often the operator of the oil and gas project and is responsible for overseeing the work of the drilling contractor as well.

In a nutshell, an oil and gas partnership is a business entity that is owned and operated directly by the investors who have put their cash into the business.

Meeting the criteria

If you are an experienced investor and have an active interest in the energy sector, following stories and insights posted on useful research resources, that alone is unfortunately not enough to qualify you for participation in an oil and gas partnership.

You have to become an Accredited Investor. The way you qualify for this status is to have a net worth that is in excess of $1 million, not counting the value of your primary residence. You can also gain accredited status if you can demonstrate that you have enjoyed an annual income in excess of $200,000 for the last two years and that the same level of income is expected to continue for the foreseeable future.

The qualifying criteria makes sense as it serves to demonstrate your financial strength as well showing that you most likely have plenty of experience behind you as an investor.

Tax benefits

If you are in that sort of income and wealth bracket, it is likely that your main focus is on wealth preservation rather than searching out significant capital gains. In other words, you are in it for the long-haul and are prepared to invest your money over the longer term.

That is not to say that investing in an oil and gas partnership is not without risk to your capital, but the tax breaks on offer are tempting if you can gain that accredited status.

An accredited investor will automatically be in the higher tax bracket and this means that there are some significant tax benefits on offer specifically aimed at oil and gas investors. It is fairly typical to witness deductions of around 85% of your initial investment, even if you are investing an oil lease with a proven track record.

Most investors in an oil and gas partnership diversify to spread the risk, so they end up with a portfolio of different partnership investments, all of which qualify for some worthwhile tax benefits.

Private or public

If you are wondering about the difference between a private oil and gas partnership and a master oil and gas partnership (MLP), there is a clear distinction between the two.

A private oil and gas partnership is privately offered to a limited number of suitable investors, whereas an MLP is normally publicly traded securities and therefore more widely available.

Both are structured as partnerships for tax purposes, and while an MLP is designed to be an ongoing investment, a private oil and gas partnership investment is often created with a view to liquidating the investment for a profit at some point.

It can often pay to get some professional guidance when trying to identify a great oil and gas partnership opportunity, which means looking beyond the tax breaks and finding the investments that tick all of the right boxes.

Lola Woodward is a Wall Street watcher who loves to read everything she can get her hands on involving investing and stocks. She also enjoys helping new investors by sharing her experiences and insights on various investing and finance blogs.