Ep. 103 | Unlocking Oil & Gas Investments: Tax Benefits Unveiled

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Welcome back to the Teaching Tax Flow podcast, everybody. Episode 103 today, we are gonna dive into oil and gas and what that means as an alternative investment. But before we do that, as always, let’s take a brief moment and thank our episode sponsor.

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Hey, everybody. Welcome back to the teaching tax flow podcast. As promised, today, we are gonna venture down a path, maybe the lesser known path of an alternative investment, which I find very, very interesting only because the fact that I know very, very little about it. So as everybody knows here that has watched this or listened to this podcast in the past, I’ve known Chris Pacquero for about 24, 25 years, which I think gives me the right to talk smack to him. But, unfortunately, now that we record these on video, I can’t really edit things in or edit it out as easy.

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So we’ll let him talk smack about himself, I guess, or me because I can’t cut it out either. So Chris Pacuro, welcome back to the party, sir. How are you?

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Well, it’s great to be back. I enjoyed our last discussion. Deviated from my normal get up with my Detroit Tigers attire and, but very excited about this episode. I always say that, but I really am excited about this episode. Couple things.

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We know the three laws of teaching tax flow, and are one of them is that that tax agencies are your involuntary business partner, and tax laws are written to encourage and discourage certain behavior. That behavior could be financial. That behavior could be social. And as a tax planner and strategist myself, I’m constantly looking for different opportunities, for taxpayers to legally and ethically reduce the tax they pay. And it’s very rare that I get to bring in a resource that we work with in our private CPA practice and introduce them, to the teaching tax flow community, so I’m very excited about that.

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So we’re gonna talk today, we’ve got an expert that I’m gonna introduce in one second, talk about, the tax benefits of investing in oil and gas. And today, we’ve got Alec Hutchen, on top of being a huge Steeler fan and Pittsburgh Penguin fan, both teams that have that have caused havoc for the leagues that they play in recently. He is the vice president of investments for MDS Energy Development LLC. Alec, welcome to the Teaching Tax Flow podcast, and thank you for joining us joining us. Joining us.

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Chris, John, absolutely. It’s a pleasure to be here. Thanks for having me on today. Certainly exciting to get a chance to chat with you all and your audience on, you know, gas and oil and the tax benefits that come from investing in gas and oil here domestically in the states. It’s something that’s relatively fresh to a lot of people that hear it.

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And, really, it’s because a lot of these ventures are, you know, private producer ventures, private family office ventures. And so it’s a really good first step for the community here as a whole to be able to learn a little bit about what some of these tax codes are and the advantages of that. You know, ultimately, we’re really excited for what we have in place currently, in in the states, to be able to to to really boost and and and help these tax strategies that you have that you’re forming right now, Chris. We think that we could be a big help there.

00:04:06.735 –> 00:04:36.145
Well, let me answer your question because not many kids grow up in the front yard throwing the baseball, throwing the football around, maybe playing some street hockey in the Midwest. All 3 of us are from the Midwest originally. Saying to our dad or uncle or friend, I can’t wait to be an accountant one day. That’s what I really wanna do. And not to say that getting in the oil and gas industry isn’t an awesome field, which it is, but how did you find yourself falling into working with MDS and into this industry?

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Yeah. It it it’s actually an interesting story, but it’s it’s one that hits close to home because this is my home. And what happened was I went off to school and and got my degree in economics. You know, my my intention was always to be sort of a I always say a boring economist. Right?

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More of a a theory based economist and and really just I thought I’d be stuck writing papers. But, you know, after a couple of old fashions with Michael Steider, who is an owner of Snyder Brothers, who is a drilling operator here in Western PA, you know, I found myself in a position where I’m able to find investors for these alternative investment programs. Ultimately, it was nice because growing up here in Western PA, this is Gasland, and we have a real sense of pride here for the natural gas industry in Western PA. It has quite literally become our new steel. And so there’s a real sense of pride in community when it comes to, you know, finding investors to bring money into our area to really create, you know, jobs, and also we give back to the community in a tremendous way.

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And so I got myself involved. Like I said, I was really and still today, by the way, I’m better at understanding how these quotes fit into our portfolio than how we actually drill the wells. But with that being said, I did happen to have a pretty good start head start on the jargon of the natural gas industry as well, and so it was a pretty easy fit.

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Well, that’s cool. And a couple couple side notes here. 1, I’m not a condesser of fine drinks. I’m a I’m a beer converted to wine guy. However, when you come back to Nashville, Alec, I will take you out for some an amazing old fashioned.

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Johnny t indulged in one recently, and now it’s a must stop spot when he comes to it’s it’s in Franklin, but in in Nashville. The other thing is it’s really cool that you have stayed close to home. You know, we think about, cities and in, like, the Steel City or the Music City or the Motor City. And and most people, when they think of oil and gas, they think of Texas or maybe Oklahoma. But but little known to many is that Pennsylvania, this is a very important part of your economy, and it’s gotta feel good growing up as a Pennsylvania native to be able to work at a company and and that helps, like you said, the community and to, to create jobs and and industry in your in your home state.

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Yeah. Absolutely. And by

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the way, when when when I try out a a a Nashville old fashioned, I’ll make sure I get you a 16 ounce Iron City up here one day too, you and John. That way, you guys, I can I can return the favor? But there’s certainly a sense of pride here. Obviously, the Marcellus Shell Basin stretches over the better part of of Pennsylvania, but, ultimately, almost all of the entire part of the Western PA. And so it’s an absolute massive boost to our economy here.

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Like I said, it is our largest GDP here in Pennsylvania, but also specifically in Western PA is where the largest amount of production is coming from. And so ultimately, the Marcellus shell is is is really a source rock. It’s different than a lot of the other basins in our country. It’s it’s a a very high producing basin, and it’s also one that at this point in time, with the advancements of technology, is one of the most efficient and relatively easiest basins to extract production from and see high level production from the wells. And so the actual process that we utilize here in the Marcellus is really efficient.

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There really is no such thing as a dry hole anymore in the Marcellus Shell Basin. And so whereas opposed to a lot of programs in the Midwest and even in Texas are ultimately, you know, seen as exploratory at times, wildcatting, That is sort of a byproduct of an oil play. You know, with natural gas plays in Western PA here, you know, we don’t see those dry holes, or we don’t see those holes, you know, come up empty as often or at all. And therefore, it just becomes a really strong, a really strong market for our community here. We don’t see a lot of losing ventures, with that being said, as far as programs coming up empty handed with no production.

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Well, can you walk someone through I mean, you know, a lot of people, especially, you know, growing up in maybe a more of a blue collar area, always equate and I put myself in that category. Right? And I equate oil and gas. Oh, that’s what these these rich people do. You gotta have 1,000,000 of dollars to get involved with that.

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But, you know, can you talk us through some of the tax advantages of of why, you know, that perception is is that there are advantages to investing in oil. Gas, but a lot of people, when you press them, can’t explain those them at all. And and, obviously, it’s being able to invest in oil and gas is much more readily available than it was even 15 12, 15 years ago. But what are some of the tax advantages, aside from from availability?

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I think I think you just said it perfectly, Craig. I mean, the availability piece is is a massive variable to the answer here. And and the reasoning why people were so stuck in the thought process of this being for the upper upper class for the entirety of of their lives is because, well, it was. I mean, a lot of these private ventures, again, they are private ventures. They’re just that.

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And so it’s really hard to get into the door. But like you said, Chris, over the years, scalability in the industry has allowed us to achieve financial models now at price points that are so lucrative that it does make sense to try to scale your your ventures. And so there are opportunities out there right now where some of these offices and some of these private ventures are actually looking for capital, which is where we can step in and take advantage of that as investors. There are major tax implications that flow through to investors from these programs, and we’re gonna spend some time today talking about the intangible drilling cost deduction. And, Chris, we talk about this all the time across the board.

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It’s not like any specific producer has an opportunity to take advantage of it, another doesn’t. It’s actually a code that’s utilized by all gas and oil operators in the space. The nice part about being an independent producer, or if you are an independent producer, I should say, is that you can capture the entirety of this intangible drilling cost deduction the year that you drill the well domestically here in the states. And so really quick, the intangible drilling cost deduction, what it is, is it’s any material that we use when you’re drilling a fresh producing gas or oil well here domestically in the United States. All that material can be taken as an above the line deduction the year the well starts to produce.

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And so it could be really powerful when you put it into a portfolio. Again, that’s an above the line deduction, which for those of you that don’t know how it flows through, is really like an active business loss deduction. And so ultimately, it’s coming right off your adjusted gross income on the year. This is one of the only investment structures that I know where you’re actually eliminating dollars off of your AGI, and you’re actually eliminating taxes. We’re not kicking the can down the road.

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And we also don’t have to amortize our deduction over the 5 to 7 years like most programs do as well. We’re able to take this IDC deduction all in the 1st year that the investment’s made, thus making it one of the most powerful codes in the internal revenue code today.

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So I what we call IDC in our business, so intangible drilling costs, as Alec mentioned, it’s it’s kind of like, you know, bonus depreciation that you don’t have to recapture if you wanna put it you know, we had a very popular episode recently on bonus depreciation, but, you know, in there’s there’s a lot of great tax strategies that utilize bonus depreciation, for instance, cost segregation studies. But, ultimately, with bonus any depreciation deduction, you have to you have to recapture that when the asset is sold, where with IDC, it sounds like you get an immediate deduction without recapture.

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Yeah. Absolutely. Yeah. It it differs in in a really a stronger way. And, ultimately, again, this has been in the internal revenue code for just a 101 years this year.

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It’s it’s its 101st birthday this year. So we just crossed the 100 year mark. It’s been around forever. We don’t see it going anywhere anytime soon, nor have we heard anything about it ever being abolished. And so, ultimately, it’s a really strong code that’s set in place too.

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And so some of the turbulence that surrounds some of these other strategies that you have to wonder, am I still gonna be able to take advantage of this next year? Right? Some of these strategies that we talk about so often on the tax side, we sort of know that we’re stuck in place with this IDC deduction moving forward as well. And so we find a lot of comfort in that, Chris, too, when we’re doing tax planning with investors and they take advantage of this, deduction that they feel comfort that they will have it again next year if needed.

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And, Alec, a question for you too. I know you mentioned that in, you know, in your neck of the woods over there. Unfortunately, it’s where the Pittsburgh Penguins play. And as Alec knows, I’m a Detroit fan. So we’ll we’ll leave that for a whole another episode since we’ve spun we can’t cut out bloopers as much.

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So I I know you mentioned in in your area there, so you don’t really see a lot of the challenges of, frankly, coming up empty empty handed as some other areas of the country. But then also, you know, you mentioned the, you know, the IDCs really don’t kick in until the well is producing. Just out of curiosity, what’s usually the time frame, you know, pun intended, but not really, you know, putting a shovel on the ground until you’re actually producing. What’s the average turnaround there?

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Yeah. It it it’s gonna depend on how you structure your fund, and there’s multiple funds out there that structure a a slightly different, John. And, really, what it comes down to usually is money and what how much capital you have liquid right away. Right? These projects in themselves, let’s just say on a typical 10 pad, 5 well per pad project, 50 wells being drilled, you’re gonna be looking at somewhere between 12 to 18 months to get these wells completely drilled.

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Now the unique thing about wells here in the Marcellus is that we’re drilling horizontal wells primarily. Most operators are today. It’s the most beneficial or the most bang for your dollar when you’re drilling. Right? Again, it goes back to that scalability portion.

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How can we find a more efficient model, and how can we keep plotting to find that? Ultimately, you know, when you’re drilling a well, if you drill a shell, the actual vertical portion of the well is still considered a producing well. And so in our industry, it is considered a spudded well. And if you spud your well by December 31st that year, you can take the full IDC deduction assuming that you already paid for the material that’s gonna go into the completion process. And so, again, it’s not really a workaround.

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It’s just simply in section 263 c of the internal revenue code. Right? That explains that we could do this. But, ultimately, at that point, it’s considered a shallow well, the vertical section. And so what you could do as an operator to make sure that you cut that time line down, right, for investors to actually see some income flowing from programs like that and the gas point of space, you know, you can make sure your wells are spud at all by December 31st this year and go back in and complete them in the early part of next year.

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And what I mean by that is complete the actual lateral process. And so, ultimately, you can still take the full IDCs in this method. Now there are programs out there that just decide to cut that IDC in half between year 1 year 2. Right? And so you can see programs that might not have as much capital right away.

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I know some ventures where family offices put up a lot of money right away to get the vault ruling. But with that being said, other ventures might split that. And so the IDC deduction, you can see split between multiple years. And, ultimately, if you don’t even exhaust the IDC deduction the year that you receive it, it actually just carries forward as a net operating loss. And so you never you lose your deduction from a gas and oil program.

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You actually can take advantage of it in the future. And there’s another interesting strategy there too, Chris, because high w two income earners, you know, you could put a large lump sum in today, carry forward your deduction over 5 to 6 years on your own schedule, and then ultimately make sure your cash flow is flowing as early as possible.

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Absolutely. So this is a and that’s a couple of things. 1, this is a this is a this is a tax strategy or consideration for someone that is a w two earner, that that wants to participate in in something like this. Side note, the only spud that John knows about is probably spuds Mackenzie, but that’s a whole another episode also. Now the harassment We talked we take and receive.

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We talk about we talked about IDC, so that’s a really an immediate benefit that you’re receiving. There are a couple other tax benefits that you told me about previously that I wanna touch on before we wrap up. One of them is on your income while you receive it, and one of them is at the end of things, potentially, I think. So while you’re receiving your income, not a 100% of it is gonna be taxable. I believe there’s some type of depletion allowance.

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And then my there are some of these oil and gas investments eligible for a 1031 exchange?

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Yeah. No. Those are great topics to touch on, and, ultimately, we’ll start with the depletion allowance. Like you mentioned, Chris, it is a tax advantaged income stream that’s flowing from these gas oil programs as well. All of the programs will take advantage of this percentage depletion allowance, which really all it really means is it’s a deduction that we get on our gross income that’s flowing from these gas and oil wells when they’re fresh producing.

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Ultimately, it just allows investors to take that deduction based on the exhaustible mineral deposits that are included in the depletion of the the the actual wells themselves. And so due to the the depleting asset aspect of the program, again, we do capture that 15% depletion allowance. And so, ultimately, in a nutshell, 85% of your income stream is taxable on the life of these gas funnel programs. And so while it is flowing through as ordinary income, you are typically seen as an active participant in the business. It’s nice to have the tax advantages as well throughout the life.

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Again, some of these gas oil programs can last up to 40 years, And so we’re talking about a pretty lengthy income stream, and those tax advantages are really well received over the life of that 40 years. And and the second part, Chris, like you like you mentioned, can you repeat that one more time? Sorry.

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Yeah. Are are these investments, are any of them eligible for a 10 30 one exchange, let’s say, down the road if it’s if it’s sold?

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Yeah. Then and then that’s probably why I I I lost you on it because for for for some, they are, and for some, they they are. Yeah. So, ultimately, it’s it’s a situation where, I am not as familiar with being able to utilize these 10 30 one exchanges. Nobody in the Marcellus Shell Basin that I’m extremely familiar with is utilizing that structure.

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However, I do know it’s out there. And so I do know there are ventures that take a, you know, take a piece of that or or take advantage of being able to utilize this inside of a 10/31. Where most gas and oil plays come into advantage on a 10/31 situation, to be honest with you, and the ones that I’ve worked with firsthand, is if you’re looking to pull out of a 10 30 1 exchange. Yeah. If you’ve been sitting on a 10 30 1 exchange or been wanting to pull out but you just don’t wanna take that tax hit, you know, you can take separate monies, put it into one of these gas and oil programs, and that IDC deduction will actually eliminate, most of that taxable income that was created from the 10 30 one exchange pullout.

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Right? Absolutely. So you’re looking at with oil and gas, we’re looking at a situation where, one, you could, you know, get a a 100% immediate deduction under IDC. 2, your income is, in general, 85% taxable be because of intangible or intangible drilling costs. And 3, it could it could be considered a replacement property under this right circumstance if you or rather if you have a failed 10 30 1 exchange.

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It’s a remedy for a failed 10 30 1 exchange. So let’s say you really wanted to do an exchange. You’re sitting on cash that you don’t really need, and you wanna deploy it into something. It ultimately has the same effect of doing the 1031 exchanges by by maybe taking advantage of the intangible drilling costs. So that’s how I’d wrap the 1031 into this conversation.

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And, well, man, this has been amazing. What you know, as we wrap up, what what kind of advice could you give someone that might be interested in exploring, no pun intended, oil and gas? And and, is there typically, you know, something someone should consider that we may not have touched on?

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No. I always I always like to say the big 3 when it comes to most gas and oil programs that I talk about. I always end all of my speeches and all of my all of my webinars and all of my presentations with the same three variables. And when I speak to people, I try to speak to you, making the best decision as an investor out there in the space, not so much on a specific program, but just if you’re educated enough to understand what to look for inside of these programs, you’ll find yourself making the right choices time and time again. The big three variables, everybody, when it comes to gas and oil and the 3 that I always talk about are are number 1 being, what does the leverage look like inside of a program?

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What kind of leverage? What kind of financing is coming alongside the operations? It’s always good, obviously, to have as little leverage as possible. But when you’re going into a commodity that is so volatile or is as volatile as a gas or oil is, it’s really, really beneficial to have either as little leverage as possible or, ultimately, no leverage is ideal in these situations. Again, it just gives you complete flexibility and control of your gas production, which is absolutely instrumental in having success in a volatile market that we see, or the volatile market that we see that that is natural gas oil.

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B, making sure that whoever you’re investing with or whatever you’re getting involved with, make sure that they understand where they’re drilling, right? Ultimately, I think it’s really important to know that every basin in our country is different. It’s a different makeup, scientifically speaking and geologically speaking. It’s a completely different makeup across the board. And so understanding or making sure they have an understanding of where they’re drilling and what they’re doing.

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And then the C part of this is understanding the operator, right? Making sure you understand the operator is the difference between who’s drilling the well and who’s operating the well. And so understanding and having the knowledge there is really important as well. Ideally, you have it all under the same umbrella. That way, you’re investing with whoever has complete control.

00:23:07.835 –> 00:23:22.530
But with that being said, there are great operators out there in the space. And so just understanding what to look for in those 3. Usually, those 3, the answers to those 3 questions right there will will lead you to a pretty good, guesstimate on how the program is gonna perform.

00:23:23.230 –> 00:23:31.055
That’s awesome. And that’s probably the best way to close it out, I mean, as we drill down. So Oh, goodness. Show full of dad jokes over here. You know?

00:23:31.055 –> 00:23:41.600
And I I gotta take advantage every opportunity I have to to razz on the Pittsburgh Penguins. I have to take it. And then all the dad jokes. So this is, you know, this is one of my favorite episodes I think we’ve had here.

00:23:41.600 –> 00:23:47.780
No. It’s And out Like that that Marc Andre flurry save in 2009 might might haunt you a little bit. Your dreams at night.

00:23:48.480 –> 00:23:54.195
I don’t wanna speak. I’m done speaking. Chris, you know this guy? We’ll we’ll let him we’ll let him in the podcast door.

00:23:54.355 –> 00:24:00.195
Hey. You know what? You gotta you you gotta respect it, though, man. You can’t it’s not some fluky, organization. So Yeah.

00:24:00.195 –> 00:24:04.835
You got too. So you guys got one from us too, so we swap one for 1.

00:24:04.835 –> 00:24:09.475
It it happens. It it happens. You know, you can’t stay on top all the time. You know? Like, when you drill, pull the surface.

00:24:09.475 –> 00:24:31.015
Anyways, no more no more dad jokes. Alec, this was awesome, man. I I really appreciate you taking the time to walk through this, and, especially, I’m glad that we went down the avenue of kind of explaining on how it works, the actual process itself, not just alright. Well, cool. You know, dollar for dollar or however things work out, you know, because it sometimes, I I think and this is my own opinion.

00:24:31.475 –> 00:24:51.540
It is I think, you know, literally, this falls under alternative investments as the category. Right? So I think just that alone, many people tend to shy away from it because they don’t understand it. So I I absolutely love and appreciate, you know, your your openness to it and the way you describe it. And and I like the fact that you started with that and not ended with that.

00:24:51.540 –> 00:24:58.235
Like, hey. This is literally how it happens, where usually it’s the other way around. Right? So Yeah. I the operation.

00:24:58.235 –> 00:25:27.775
I I think I think I could speak for most of of us in the alt space, but especially us here. I mean, we really believe that we’re building the infrastructure of America. And so, ultimately, you know, we need these ventures to make America tick. And so, ultimately, there’s a lot of morality and investing across the board at alts, but especially in energy. We need affordable energy to make sure that single moms can feed their kids, and to make sure that we can still continue to maintain a really prosperous life for the middle class.

00:25:27.835 –> 00:25:29.035
And so we find a

00:25:29.035 –> 00:25:43.850
lot of pride in that. Absolutely, man. Well, again, we we appreciate you joining us on this. Anybody that’s watching it, you’ll see obviously in the description below this podcast. But, also, if you’re just listening to it too, there’ll be some contact information in there, some more information on this topic.

00:25:43.990 –> 00:25:46.335
And, yeah, we’ll I look forward to having you back, man.

00:25:46.575 –> 00:25:52.915
Yeah. Absolutely. Yes. Thank you so much, and I know y’all have a great rest of the day. Thank you both.

00:25:52.975 –> 00:25:53.535
Excellent, guys.

00:25:53.535 –> 00:26:03.910
Well, I appreciate both of you joining us here. And as I always like to close out, we’ll see everybody back here next week, roughly about the same time, but a completely different topic here on the Teaching Tax Flow podcast.

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00:26:26.506 –> 00:26:36.606
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