Oil and Gas Transactions, written by Noah S. Baer, Esq., analyzes the principal domestic federal income tax aspects of acquiring various types of interests in oil and gas properties. It also examines the acts of exploring, developing, and operating the properties. It also examines the various types of arrangements and organizations used in the process; the depletion allowance; intangible drilling and development costs; production payments; and the application of other areas of the Code to the oil and gas industry.
The acquisition, exploration, and development of properties for the production of oil and gas require the investment of considerable capital and often involve the assumption of considerable risk, particularly with respect to previously undeveloped properties. The owners and operators of such properties use a variety of techniques, in addition to the usual debt financing, for financing the development of the properties and for spreading the associated risk.
The selection of a particular financing technique involves the consideration of tax, economic, and other factors. The tax considerations can materially affect the anticipated income to be realized on the investment of capital and often determine the form and feasibility of the particular investment in the property.
The Worksheets contain a copy of the American Petroleum Institute's Model Tax Partnership Agreement with commentary and relevant Internal Revenue Service position papers.
Oil and Gas Transactions allows you to benefit from:
This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which covers every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more.
Detailed Analysis
I. Introduction
A. Background
B. Summary of Basic Concepts
1. Investment in the Oil and Gas Property
a. Economic Interest
b. The “Property” Concept
c. Operating and Nonoperating Interests
2. Expenses and Cost Recovery
a. Leasehold Costs
b. Exploration Costs
c. Intangible Drilling and Development Costs
d. Depletion
3. Conveyances - Sale or Lease
a. General Considerations
b. Royalties
c. Production Payments
4. Joint Investments
a. Pool of Capital
b. Sharing Arrangements
II. Acquisition of Interest
A. General Principles
B. Economic Interest
1. Investment in the Minerals in Place; Income Derived from Extraction
2. Sale of Oil and Gas for a Return of Capital
C. Types of Conveyances
1. Exploration Option
2. Lease or Sublease
a. General Principles
b. Working and Operating Interests
c. Royalty
d. Net Profits Interest
e. Shut-In Royalty
f. Minimum Royalty
g. Lease Bonus and Delay Rentals
h. Production Payments
3. Sale or Exchange
4. Like-Kind Exchanges
b. Application to Oil and Gas Transactions
(1) Operating Interests
(2) Royalty Interests
(3) Production Payments
c. Partnerships
d. Pipelines
e. Crude Oil
D. Assignment of Non-Operating Interest
1. Overriding Royalty
2. Carved-Out Production Payment
b. Historical Background
c. Tax Treatment
3. Net Profits Interest
4. Sharing Arrangements
b. Production Payment Pledged for Exploration or Development
c. Service Providers
E. Assignment of Operating Interest
1. Sublease
2. Retained Production Payment
a. Historical Background
b. Tax Treatment
3. Sharing Arrangements (Retention of Part of Operating Interest)
b. Farm-Out Agreement
c. Carried Interests
(1) Pay-Out Arrangement
(2) Free Well Arrangement
d. Service Provider
F. The Property Concept
1. General Principles
2. Aggregation of Operating Interests
3. Aggregation of Non-Operating Interests
G. Unitizations and Pooling Arrangements
1. General Considerations
2. Formation
b. Like-kind Exchange Analysis
c. Partnership Analysis
III. Cost Recovery - Exploration and Development
B. Exploration Costs
2. Types of Agreements
3. Geological and Geophysical Costs
C. Intangible Drilling and Development Costs
1. Definition
2. Election
a. In General
b. Foreign Wells
d. Affiliated Groups
3. Prepayments
b. Cash Method Taxpayers
c. Accrual Method Taxpayers
4. Drilling for an Interest
5. IDC Recapture on Disposition
a. Section 1254 Property and 1254 Costs
b. Dispositions
c. Partnerships and S Corporations
6. Effect on Earnings and Profits
7. Section 59(e) Election
8. Alternative Minimum Tax Treatment
D. Depreciation
2. The Modified Accelerated Cost Recovery System (MACRS)
3. Drilling for Interest
4. Unitization Exchanges
5. Recapture of Depreciation
6. Alternative Minimum Tax Treatment
E. Uniform Capitalization
2. Application to Oil and Gas Property
a. Preacquisition Costs
b. Postacquisition Costs
c. Development Costs
d. Interest Costs
F. Section 199 Deduction
1. Qualified Production Property (QPP) and Domestic Production Gross Receipts (DPGR)
a. Extraction
b. Transportation
2. Qualified Production Activities Income (QPAI)
a. Depletion
b. IDC and G& G
c. Extracted Product Used On-site
3. Joint Ventures
4. Construction Activities
5. Exchanges and Hedges
a. Exchanges
b. Hedges
G. Other Expenses
1. Tertiary Injectant Expenses
2. Dry Hole and Bottom Hole Expenses
H. Losses
1. Section 165 Losses
2. At-Risk Provisions
3. Passive Activity Losses
4. Section 172(f) Specified Liability Losses
IV. Cost Recovery - Depletion
A. General
B. Cost Depletion
1. General
2. Bonus
3. Restoration of Depletion on Bonus
4. Selection Bonus
5. Production Payment
6. Net Profits Interest
C. Percentage Depletion
1. Background
2. Independent Producers and Royalty Owners
a. General
b. Related Parties
c. Marginal Production
d. Exclusions
(1) Retailers
(2) Refiners
e. Transfers after October 11, 1990
D. Gross Income from the Property
2. Production and Manufacturing
3. Stored Minerals
4. Take or Pay Contracts
E. 100% Taxable Income Limitation on the Property
F. Taxpayer's 65% Taxable Income Limitation
G. Special Taxpayers
1. Partnerships
2. S Corporations
3. Trusts and Estates
4. Controlled Group of Corporations, Businesses under Common Control, and Members of the Same Family
5. Fiscal Year Taxpayers
6. Income in Respect of Decedents
7. Community Property
H. Excess Percentage Depletion
1. Adjusted Basis for Determining Gain on Sale
2. Alternative Minimum Tax Treatment
I. Recapture of Depletion
V. Tax Credits
A. Credit for Producing Fuels from Nonconventional Sources (Section 45K)
B. Credit for Enhanced Oil Recovery (Section 43)
1. In General
2. Qualified Enhanced Oil Recovery Costs
3. Qualified Enhanced Oil Recovery Project
b. Application of One or More Qualified Tertiary Recovery Methods
c. First Injection of Liquids, Gases, or Other Matter Occurs After December 31, 1990
d. Project Certification
e. Election to Have Section 43 Not Apply
4. IRS Examination Guidance
C. Marginal Well Production Credit (Section 45I)
2. Qualified Crude Oil and Natural Gas Production
3. Credit Reductions
4. Carryback
D. Low Sulfur Diesel Fuel Production Credit (Section 45H)
VI. Joint Operations
A. Forming and Electing Out of Tax Partnerships
2. Forming a Tax Partnership
3. Electing Out of Partnership Status
a. Determination of Partnership Taxable Income
b. Co-ownership Requirement
c. Take In-kind Requirement
d. No Joint Selling
e. Gas Balancing Rules
f. Making the Election
g. Effect of the Election on Non-Subchapter K Code Sections
(1) Interdependence
(2) Foreign Partnerships
4. Use of Tax Partnerships
a. Special Allocations
b. Avoiding Rev. Rul. 77-176
c. Reimbursement of Preformation Capital Costs
B. Operating the Partnership
1. Basis
a. Partner's Basis in the Partnership (“Outside Basis”)
b. Depletable Basis (“Inside Basis”)
2. Partnership Elections
b. TEFRA
3. Depletion
4. Special Allocations
a. Economic Effect
b. Substantiality
c. Capital Accounts
(1) General Principles
(2) Simulated Depletion
(3) Tax Credits
(4) Regulation Example 19
5. Built-in Gain or Loss
6. Sale or Exchange of Partnership Interest
a. General Rule
b. After 761 Election
VII. Additional Topics
A. Geothermal Wells
1. Depletion
2. Intangible Drilling and Development Costs
3. Recapture of Depletion and IDC
4. Depreciation
5. Tax Credits
a. Energy Produced from Certain Renewable Resources (Section 45)
b. Energy Credit (Section 48)
6. Sections 465 and 469
B. Nonconventional Fuel Credit (Section 45K)
1. Qualified Fuels
a. Oil Produced from Shale and Tar Sands
b. Gas Produced from Geopressured Brine, Devonian Shale, Coal Seams, and a Tight Formation
c. Gas Produced from Biomass
d. Liquid, Gaseous, or Solid Synthetic Fuels Produced from Coal (including Lignite), including such Fuels When Used as Feedstocks
(1) “Qualified Fuel” Private Letter Rulings
(2) Placed in Service
(3) Coke and Coke Gas
2. The Credit
Working Papers
Table of Worksheets
Worksheet 1 IRS Petroleum Industry Overview
Worksheet 2 GCM 22730, 1941-1 C.B. 214
Worksheet 3 IRM Figure 3-1 on Tax Treatment of Payments Under an Oil and Gas Lease
Worksheet 4 IRS Field Directive on Cost Depletion - Determination of Recoverable Reserves
Worksheet 5 IRM Exhibit 4.41.1-5 (7-31-2002) Classification of Expenditures in Acquisition, Development, and Operation of Oil and Gas Leases
Worksheet 6 IRM Exhibit 4.41.1-3 (7-31-2002) Useful Examination Techniques - Lease Acquisition Costs
Worksheet 7 IRM Exhibit 4.41.1-4 (7-31-2002) Useful Examination Techniques - Intangible Development Costs (IDC)
Worksheet 8 Coordinated Issue Paper on North Sea IDC Transition Rule
Worksheet 9 Coordinated Issue Paper on Capitalization of Delay Rentals
Worksheet 10 Coordinated Issue Paper on Deductibility of Estimated Dismantling Cost for Offshore Platforms
Worksheet 11 Coordinated Issue Paper on Recoverable Reserves for Cost Depletion
Worksheet 12 Industry Director Directive #1 on Enhanced Oil Recovery Credit
Worksheet 13 Industry Director Directive on IRC Section 172(f) Specified Liability Losses
Worksheet 14 American Petroleum Institute Model Tax Partnership Agreement
Worksheet 15 Commentary to API Model Tax Partnership Agreement
Worksheet 16 Oil and Gas Elections
Worksheet 17 Section 45K Inflation Adjustment Factors, Reference Prices and Phase-Out Amounts
Bibliography
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Statutes:
Regulations:
Legislative History:
Treasury Rulings:
Cases:
Text and Treatises:
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