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The Hudsons live in New York City, make $1.4 million per year, are contemplating an oil and gas well investment. Why? Let’s delve into their financial journey, year by year, comparing it to a typical stock portfolio. Below is a quick reminder of the risks and benefits of oil and gas well investments:
The Hudsons, who expect to pay $700,000 in taxes on their $1.4 million income, are choosing between investing $200,000 in oil and gas or in the stock market. Let’s walk through the potential returns.
Depreciation: The Hudsons expect to receive 88% of their investment as depreciation in the first year. Since their marginal income tax rate is 50%, that depreciation will save them $88,000 in taxes this year (or 44% of their investment). This effectively lowers their-out-of-pocket investment in the oil and gas from $200,000 to $106,000 because $88,000 is money that would have otherwise been lost to taxes. Critically they will also receive depreciation for the additional 12% of their investment over the next 6 years, lowering their out of pocket investment to $100,000.
Oil & Gas Returns: The Hudsons examined the historical annualized returns for their producers’ oil and gas wells based on the years the wells were drilled. Here’s what they found:
| Year | Return |
| 2022 | 20.40% |
| 2023 | 38.18% |
| 2024 | 43.39% |
| 2025 | 18.13% |
| 2026 | 11.31% |
| 2027 | 8.87% |
| 2028 | 13.64% |
| 2029 | 10.96% |
| 2030 | 8.97% |
| 2031 | 3.84% |
| 2032 | 5.65% |
| 2033 | 5.48% |
| 2034 | 3.70% |
| 2035 | 2.57% |
Convinced, they take the plunge.
Year-by-Year Cash Flows from Oil & Gas
Based on their $200,000 investment, here’s what the Hudsons can expect in terms of returns:
| Year | Return Calculation | Annual Income |
| 2022 | $200,000 * 20.4% | $40,800 |
| 2023 | $200,000 * 38.18% | $76,360 |
| 2024 | $200,000 * 43.39% | $86,780 |
| 2025 | $200,000 * 18.13% | $36,260 |
| 2026 | $200,000 * 11.31% | $22,620 |
| 2027 | $200,000 * 8.87% | $17,740 |
| 2028 | $200,000 * 13.64% | $27,280 |
| 2029 | $200,000 * 10.96% | $21,920 |
| 2030 | $200,000 * 8.97% | $17,940 |
| 2031 | $200,000 * 3.84% | $7,680 |
| 2032 | $200,000 * 5.65% | $11,300 |
| 2033 | $200,000 * 5.48% | $10,960 |
| 2034 | $200,000 * 3.70% | $7,400 |
| 2034 | $200,000 * 2.57% | $5,140 |
In the first year, the Hudsons can depreciate 88% of their oil and gas investment, or $176,000. Given their 50% marginal tax rate, this translates to a tax saving of $88,000 in the first year alone.
In addition, 15% of the income from the oil and gas wells are tax exempt! That’s a huge, overlooked benefit of investing in this space.
You might be wondering what these benefits look like over time . . .
If the Hudsons are able to replicate these previous returns, then over 14 years they will get $127,000 in post-tax benefits from their $200,000 investment! If they invest in oil and gas wells and reinvest the cash flow in the stock market, they will end up with roughly 35% more in assets than if they had just invested in the stock market for 20 years. Another way to think about it is that the tax savings create leverage. That leverage allows investors like the Hudsons to invest more in oil and gas wells than they would have been able to invest in the stock market otherwise, because they can invest dollars that would have been lost to taxes. You can estimate what the returns could look like in your situation on our calculator here.
If the Hudson’s had use Solar to offset their oil & gas income they could have increased their return potentially 20% or more. You can see how it works in this case study or estimate your potential returns in this calculator.
The Hudson family took a calculated risk by diving into oil and gas well investment. The considerable tax benefits of 100% depreciation of their investment (88% in the first year), the 15% income exclusion, and the strong returns from the underlying investment allowed them to generate after-tax returns that a typical, broad stock portfolio wouldn’t have been able to generate.
By taking this route, they turned their $200,000 into a tax-efficient and highly profitable investment, proving that sometimes the road less traveled is worth taking.
Want to see how this could work for you?
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From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $3 billion in additional wealth for our customers. If you would like to learn more, please feel free to explore our Learning Center. You can also see your potential tax savings with our online calculators or schedule a time to chat with us!
