Direct participation in domestic energy development — a strategy uniquely capable of offsetting ordinary income in the year of investment.
Section 263(c) of the IRS tax code provides taxpayers the option to fully deduct, as expenses, the intangible drilling costs ("IDCs") incurred for new oil and gas wells.
Because IDCs are normally paid in the first year and are allocated first to General Partner investors, this deduction generally results in a significant ordinary-income tax write-off in the year of investment. Typical IDCs include costs from drilling, hydraulic fracturing ("fracking"), wages, fuel, repairs, hauling, supplies, and other expenses necessary for drilling and preparing a well for the production of oil and/or natural gas.
Most tax-advantaged strategies defer capital gains. Oil & gas IDC deductions can offset ordinary income — making this one of the few tools available to high earners with W-2 or business income rather than a one-time asset sale.
For investors, IDC deductions flow from Schedule K-1 to Schedule E, to Schedule 1, and ultimately to Line 8 of Form 1040. IDCs do not include the lease or equipment costs paid for an oil and gas well — those tangible costs are classified separately and recovered over time through depreciation.
The table below reflects historical Permian Basin investor returns reported by U.S. Energy Development Corporation, one of Thornwood's energy program sponsors, across its recent drilling funds.
| Drilling Program | Permian Capital Expenditure¹ | Well Count | Cash-on-Cash Return² | Cumulative Tax Savings³ | % Cash & Tax Savings |
|---|---|---|---|---|---|
| USEDC 2018 Drilling Funds | $11,900,426 | 5 | 109.39% | 80.07% | 189.45% |
| USEDC 2019 Drilling Funds | $46,188,146 | 12 | 103.46% | 85.10% | 188.56% |
| USEDC 2020 Drilling Fund | $52,911,984 | 21 | 141.14% | 103.63% | 244.77% |
| USEDC 2021 Drilling Fund | $93,977,109 | 40 | 72.77% | 97.65% | 170.42% |
| USEDC 2022 Drilling Fund | $169,864,363 | 35 | 54.39% | 53.01% | 107.40% |
| USEDC 2023 Drilling Funds | $318,753,258 | 96 | 33.68% | 53.71% | 87.39% |
| Total | $693,595,286 | 209 | — | — | — |
¹ Represents capital deployed and any remaining capital to-be-deployed in the Permian Basin. Permian capital expenditure as a percent of total capital raise — 2018: 15%, 2019: 65%, 2020: 85%, 2021: 84%, 2022: 71%, 2023: 91%.
² Cash-on-Cash Return is calculated as total investor asset return less pro-rata partnership-level expenses, in each case allocated to Permian Basin assets, divided by Permian Basin capital spent as of the date of this report.
³ The tax rate includes the maximum federal rate plus the average state income tax rate of 6.57% based on the tax rate of those states that have a state income tax. Depreciation was applied using an estimated five-year recovery period (straight-line) for wells allocated tangible well equipment. Past performance is not indicative of future results.
Direct oil & gas participation tends to suit investors who have substantial ordinary income to offset, who can tolerate the higher risk and illiquidity of energy development, and who qualify as accredited or sophisticated investors. As with all of our strategies, suitability is determined in coordination with your tax advisor.
