7858 / Why are oil and gas limited partnerships attractive to individual investors?

Small investment. Although the dollar amount needed to purchase a partnership interest in an oil and gas limited partnership would be considered large by many individuals, it is in fact quite modest when compared to the capital required to complete an oil and gas venture.

High front-end deductions. In many oil and gas programs, the investor will be able to take first year income tax deductions for the intangible drilling and development costs associated with drilling the wells. Because a high percentage of the investor’s initial investment goes to pay these intangible costs, these deductions are substantial, often exceeding 60 percent of the initial investment (see Q 7866 to Q 7869). However, for certain limitations on the use of deductions, see Q 7862.

Continuing tax shelter. As most investors will be permitted to take deductions for percentage depletion on producing wells, otherwise taxable income (whether in the form of cash distributions from the oil and gas program or income from other sources of the taxpayer) will be “sheltered” to the extent of those deductions (see Q 7874). For limitations on the use of losses to offset income outside the oil and gas program, see Q 7862.

Striking it rich. Although not always an economic reason for investing in oil and gas, the fact remains that many investors hope to “strike it rich” by hitting a “gusher”.

A successful exploratory well can produce a 10 to 1 (or even greater) profit on the investor’s capital investment. Even development wells often produce in the area of a two to one profit.

Liquidity. Although not as liquid as many other investments, an informal secondary market and provisions in many partnership agreements providing for periodic offers from the general partner to purchase interests of the limited partners, or permitting a limited partner to exchange the partnership interest for the stock of the general partner (assuming the general partner is a corporation), create a small degree of liquidity.

Limited liability. An investor who purchases a limited partnership interest is generally liable for partnership liabilities only to the extent of capital contributions to the partnership (including contributions the investor has agreed to make in the future).

Allocations of income, deductions, and credits. Within the limitations imposed by federal income tax law, the limited partnership form of organization allows the participants (i.e., the general and limited partners) to specially allocate items of income and costs (including corresponding deductions and credits) among the limited and general partners in a manner that is disproportionate to their ownership (capital) interests.