If you’re a busy owner with a big tax bill, here’s a strategy you might be overlooking: owning a working interest in an oil or gas well. I’m not talking geology; I’m talking tax treatment. The tax code gives working interests a rare “active” status, which can make certain deductions hit your W-2 or business income instead of being trapped on the passive side. Used correctly, that means real, near-term tax relief.

As a San Francisco CPA of over 25 years, I often work with business owners and high-income earners who want to make their money work smarter. Most tax strategies are about timing or deferral. This one adds a third dimension: turning certain business expenses into deductions that offset active income.

The U.S. tax code gives oil and gas working interests a special “active” status, which means that, under the right structure, the deductions can reduce taxes on your W-2 wages or business profits. When done correctly, it can create real, near-term tax savings and longer-term cash flow potential.

What Are Oil and Gas Tax Deductions?

Oil and gas tax deductions are incentives built into the federal tax code to encourage private investment in energy production. These deductions can include:

• Intangible Drilling Costs (IDCs)
• Tangible Drilling Costs
• Percentage Depletion Allowance
• Bonus Depreciation
• Passive Loss Exceptions for Working Interests

These deductions can drastically lower your taxable income and enhance your after-tax return on investment.

When a well is drilled, the project costs fall into three primary categories: intangible drilling costs, tangible drilling costs, depletion. Understanding how each works is key to seeing where the deductions appear. Together, those three levers can shrink this year’s tax bill and still provide deductions in later years, while softening taxes on future cash flow.

Intangible Drilling Costs (IDCs) – Immediate Write-Off

IDCs are the expenses you can’t touch: labor, fuel, drilling fluids, and chemicals used in preparing and drilling an oil or gas well. These costs typically make up 60–80% of a well’s upfront investment.

The IRS allows IDCs to be 100% deductible in the first year, even if the well isn’t productive. That’s a massive tax break that can reduce your income right away.

Example: If you invest $150,000 in a well project and 75% of that qualifies as IDCs ($112,500), you can write off that entire amount against your income in the same year.

Tangible Drilling Costs – Depreciation Benefits

Tangible costs include the physical equipment—rigs, tanks, pipelines, and casing—that you can touch. These are depreciated over seven years under the Modified Accelerated Cost Recovery System (MACRS).

In some cases, you may also qualify for 100% bonus depreciation (check with your CPA on the current tax law).

Example: The remaining 25% ($37,500) of your $150,000 investment gets depreciated, creating additional deductions over several years.

Percentage Depletion – Ongoing Oil Income Break

Once a well produces, you can claim a percentage depletion allowance—typically 15% of the gross income from your share of production. This continues each year until the well stops producing. This allows a portion of the revenue you receive from production to remain tax-sheltered because the resource is being depleted as it is extracted.

It’s like getting a built-in annual deduction on top of your upfront write-offs.

Note: To qualify, you must have a working interest (not just a royalty interest), and meet “small producer” thresholds defined by the IRS.

Working Interest vs. Mineral Rights

In oil and gas investing, it is important to distinguish between two very different types of ownership.

Working interest

Most investments are considered passive, meaning losses can’t offset your W-2 or business income. But working interests in oil and gas are treated as active, allowing deductions to offset active income.

That’s a game-changer for business owners with large taxable earnings.

This means you are participating in the business of drilling and operating wells. It is riskier and more involved, but it is also where the big early deductions live. When structured properly, the losses and deductions from a working interest can offset active income such as wages or business profits.

Mineral rights

This is a more passive approach. You own the rights to receive royalties from production but are not involved in operations. The trade-off is simplicity in exchange for fewer deductions. Mineral rights owners generally benefit only from depletion, not the large upfront write-offs.

If your goal is current-year tax reduction, the working interest structure is usually the one that delivers the strongest results.

Case Study: Turning a $150K Investment into Tax Savings

Let’s look at a simplified example.

Alex owns a growing service company in California and expects $600,000 of taxable income this year. The projected tax bill is substantial. After consulting with a CPA experienced in energy-related investments, Alex decides to invest $150,000 in a properly structured working-interest project.

Here’s what happens next:

• Year one, IDCs:
  Let’s say 75% of the project cost ($112,500) is intangible. Those costs are deductible in year one. If Alex’s combined marginal rate is roughly 35%, that single deduction could reduce taxes by about $39,000 in the current year ($112,500 × 35% ≈ $39,375).
• Tangible equipment:
  The remaining $37,500 is equipment. Spread over several years, that might add roughly $5,000–$6,000 of extra deductions annually (ballpark), providing more relief in years two through eight.
• After the well turns on:
  A few quarters later, the well begins paying monthly checks. Each year, a slice of that production revenue can be shielded by depletion, making the cash flow more tax-friendly.

Net-net: Alex cut this year’s tax bill by around $39k without waiting for the first revenue check, then layered in depreciation and depletion for later. That’s the power of combining timing (fast deductions) with ongoing benefits.

Is this a fit for you?
This lane is typically best for high earners with meaningful W-2 or business income who want large, legal deductions now—and who can handle some bumps. Working interests involve real risk: wells can underperform, and cash flow is not guaranteed. Many offerings are private and often aimed at experienced investors, so be honest about your comfort level.
 

Recent Tax Law Updates (2025)

Recent legislative updates may enhance or limit certain tax strategies in the oil and gas sector:

• Bonus Depreciation: Extended through 2026 for certain drilling equipment under the One, Big, Beautiful Bill Act (OBBBA).
• California Tax Treatment: California may decouple from federal IDC deductions. Check with a California CPA.
• AMT Considerations: IDCs are now partially limited under Alternative Minimum Tax calculations for some taxpayers.

Always confirm with a tax professional before making investment decisions.

Who This Strategy Is Best For

Working interests are not for everyone. They generally suit high earners or business owners with substantial income who:

• Seek large legal deductions in the current year.

• Have the capacity to take on moderate to high investment risk.

• Are willing to perform due diligence and understand the timing of returns.

If you have consistent W-2 or business income and a significant tax burden, this type of investment can be an attractive way to reduce your taxes while building an income-producing asset.

What Business Owners Ask Us Most

How much of an oil and gas investment can I deduct?

• Often 65–80% of your investment is deductible in the first year as IDCs. The rest is depreciated over time.

Do I have to be actively involved to qualify?

• No. As long as you own a working interest, the IRS treats your share as active for tax purposes—even without hands-on involvement.

What happens if the well is dry?

• You can still deduct the intangible costs. Even unsuccessful wells can generate major write-offs.

Due Diligence: A Straightforward Checklist

Before investing, here are the key steps I advise my clients to follow:

1. Get the structure in writing: Confirm it is truly a working interest for tax purposes. The structure determines whether your losses can touch active income.
2. Vet the operator: Ask for plain-English track records—how many wells, where, results vs. forecasts, and what went wrong on the misses.
3. Demand a clean budget: Itemize intangible vs. tangible costs and ongoing operating expenses. No mystery markups.
4. Model the exit now: Some early tax benefits can be “recaptured” when you sell. Plan your hold period and exit so you’re not surprised later.
5. Start small, learn the rhythm: Treat the first deal like a test. Once you’re confident in the reporting and cash-flow pattern, scale thoughtfully.

Risks & Considerations

Oil and gas investments are not without risk. Projects can fail, and returns depend on commodity prices and well performance. This strategy is best suited for business owners with high tax burdens and appetite for moderate risk.

We recommend consulting a qualified tax advisor to determine if this strategy fits your financial goals.

For clients across San Francisco and the broader Bay Area, my role as a CPA and CFO advisor is to evaluate whether these opportunities fit within a larger financial plan. Oil and gas investments can be valuable tools for timing deductions, but they come with operational risk and liquidity considerations.

A CFO-level review focuses on aligning your tax strategy with your broader financial objectives. We model cash flow, test sensitivity to performance outcomes, and ensure that the ownership structure qualifies as a working interest for tax purposes. This ensures that your deductions will flow through properly to your active income rather than being limited as passive losses.

Next Steps: Want to Reduce Your Tax Bill?

Working interests in oil and gas can deliver immediate deductions, ongoing depreciation, and long-term income potential. They are not risk-free, but they can be powerful when used as part of an integrated financial plan.

Every strong tax strategy comes with balance. Working interests deliver exceptional deductions but involve operational and commodity price risk. Wells can underperform or take longer than expected to generate revenue. The best approach is to view these investments as a small part of a diversified tax and investment strategy rather than a primary income source.

As a California CPA providing CFO services, I encourage clients to pair oil and gas investments with other long-term planning tools. These might include defined-benefit plans, deferred compensation strategies, or Opportunity Zone investments. Together, these elements create a tax-efficient ecosystem that adapts to different market cycles.

If your income is high, your tax bill is heavy, and you are ready to explore legitimate ways to manage both, let’s talk. We will analyze your current financial position, identify suitable opportunities, and build a tax plan that supports your long-term success.

Schedule your consultation today to learn how a San Francisco CPA and CFO advisor can help you turn complex tax rules into practical, profitable strategies.