“If you want different results, you have to play by different rules.”
Most investors never learn that the tax code has lanes.
One lane holds your investment income and losses.
Another lane holds your ordinary income from a W-2 or a business.
For most asset classes, those lanes don’t touch.
But there’s a legal exception hiding in plain sight.
Oil and gas working interests can cross that divider and offset ordinary income, which is why sophisticated investors keep coming back to them.
1. The “Silver Bullet” Tax Mechanics
Here’s the big idea in plain English.
With an oil and gas working interest, certain upfront costs called Intangible Drilling Costs (IDCs)
are typically deductible in year one.
And, uniquely, losses from a working interest are not treated as passive under the tax code’s
passive activity rules, so they can offset W-2 wages or business income when held in a
non-limited-liability form.
That’s what makes this feel like a “silver bullet.”
I’ve seen entrepreneurs sell a business on installment, recognize a million dollars of ordinary
income in a year, and then place a similar amount into a package of drilling projects.
Because IDCs often constitute the majority of well costs, investors can see deductions in the
range people describe as 60–90% of capital, depending on project specifics and eligibility, which
can reduce that year’s reported income dramatically.
That’s the difference between showing $1,000,000 of income and $100,000—and the tax bill
that follows.
For clarity, this is not a “credit” that pays your taxes for you.
It’s a deduction that lowers taxable ordinary income, made possible by the working-interest
exception in §469 and the treatment of IDCs under long-standing IRS guidance.
If you want a deeper dive straight from the source, read the IRS on passive activity rules for oil
and gas working interests, then skim Publication 535’s discussion of drilling costs.
For context on the investor mindset, I also break this down in our blog on how to leave your
job.
2. Cash Flow, Depletion, and Why the Code Incentivizes Energy
The second benefit shows up later—when wells produce.
By statute, a percentage of gross income from oil and gas production can be excluded via
percentage depletion for independent producers and royalty owners, commonly cited at 15%
within limits.
Practically, that means the taxes you owe on cash distributions are often calculated on only 85%
of that cash flow, all else equal.
Why would policymakers allow this.
Simple.
Energy security is a public priority, and the code uses incentives to attract risk capital into
exploration and production.
From a portfolio perspective, investors also like that many oil and gas packages aim for
mid-teens to mid-20s annual cash yields once wells are online, with the caveat that results vary
widely by basin, operator, and commodity pricing.
As always, underwriting, operator selection, and well performance determine reality.
If you want to hear more real-world stories, check out our Mailbox Money Show and the
A quick note on “intermittency” and why hydrocarbons still matter.
Wind and solar are growing fast but generate power intermittently, which is why grids balance
them with dispatchable sources.⁸ ⁹
That’s not an argument against renewables.
It’s a reminder that the energy mix is complex, and the code’s incentives reflect that.
If you want the contrarian take that influenced me, grab Alex Epstein’s The Moral Case for
Fossil Fuels.¹⁰
3. Real Risks You Must Price In
Every investment has risk.
Oil and gas is no exception, so let’s name the big three.
Sponsor risk.
This is the human factor—track record, transparency, fees, and communication.
We only work with operators we or our trusted circles have vetted over years, and we compare
fee structures to make sure incentives align.
Geology and drilling risk.
Twenty to thirty years ago, “dry holes” were more common.
Today, delineated, tier-one acreage plus modern imaging and horizontal drilling improve hit rates
dramatically, though nothing is guaranteed.
We further reduce single-well risk by investing in multi-well packages—four, eight, or more—so
a miss doesn’t blow up the deal.
Commodity price risk.
Cash flow is sensitive to the price of oil and gas.
Low prices compress returns, and high prices do the opposite.
No one controls the strip, so we underwrite conservatively and diversify across basins and
vintages.
If this resonates and you want to see how experienced investors perform diligence on sponsors,
I recorded a popular episode on vetting a syndicator.
If this helped clarify the oil and gas playbook, drop a comment with your biggest takeaway or question.
If you want a deeper primer on using inflation and taxes to your advantage, download our free
report, How to Use Inflation to Your Advantage.
If you’re a reader, my book Fire Yourself: Replace Your Working Income with Passive Income in
3 Years or Less shows the framework step by step.
And if you’re an accredited investor who wants to see deals when we have them, join the
Bronson Equity Investor Club so we can connect one-on-one about your goals.
Disclaimer
This content is for educational purposes only and is not tax, legal, or investment advice.
Consult your own CPA or advisor about your specific situation before acting on any strategy
discussed here.
Works Cited
- IRS Publication 925, Passive Activity and At-Risk Rules (2025 update), “Activities That Aren’t Passive Activities,” Working interest in oil or gas well. https://www.irs.gov/publications/p925 and PDF. IRS+1
- 26 U.S. Code § 469(c)(3), working interest in oil or gas property—exception to passive classification. https://www.law.cornell.edu/uscode/text/26/469. Legal Information Institute
- IRS Publication 535, Business Expenses (IDCs and drilling costs discussion, prior edition still instructive). https://www.irs.gov/pub/irs-prior/p535–2022.pdf. IRS
- IRS, Oil & Gas Audit Technique Guide (treatment and allocation of IDCs). https://www.irs.gov/pub/irs-pdf/p5652.pdf. IRS
- Bronson Equity resources: Blog article “How to Leave Your Job and Stop Working,” YouTube channel, and Mailbox Money Show on Apple Podcasts. Bronson Equity+2YouTube+2
- 26 U.S. Code § 613A and § 613, percentage depletion for independent producers and royalty owners and income-based limits. https://www.law.cornell.edu/uscode/text/26/613A and https://www.law.cornell.edu/uscode/text/26/613. Legal Information Institute+1
- Ohio State University Extension, “Using the Depletion Deduction to Minimize Oil and Gas Tax Liabilities” (overview of 15% percentage depletion and limits). https://ohioline.osu.edu/factsheet/SOGD-TAX3. ohioline.osu.edu
- National Academy of Sciences (PNAS), “Capacity factors for electrical power generation from renewable energy,” 2022. https://www.pnas.org/doi/10.1073/pnas.2205429119. PNAS
- Visualizing Energy, “What are capacity factors and why are they important,” 2024 overview of intermittency and CFs for wind/solar. https://visualizingenergy.org/what-are-capacity-factors-and-why-are-they-important/. Visualizing Energy
- Epstein, A. The Moral Case for Fossil Fuels. Penguin, 2014.
