Tax Advantages 0f Oil & Gas Exploration

RoYA LE ENER GY

impact e l i m i n a t e d p e e s of t h e p e r i n e r n i n e s R e n d Perils) eg investora the 100% deduction for Intangible Drilling Costs t h a t have been Po Do E e e e R R e s o s C R C B s a o yeco c r is f o r t h e Tangible wellhead equipment h a s been enhanced a n d accelerated t a D e e r B R RCM r a t a )a R e l i c ee nc ei s n C n e t m t i e c Red u a r c n t d e m i r a r i me

a

amar

HERE'S W H Y : T H E OPTION TO EXPENSE INTANGIBLE DRILLING COSTS I D C

IS

RETAINED

T h i s c e n t u r y - o l d t a x p r o v i s i o n is t h e l a b o r a n d s u p p l i e s i n c i d e n t a l s t h a t a r e n e c e s s a r y for the d r i l l i n g a n d p r e p a r a t i o n o f the well for p r o d u c t i o n o f oi! a n d n a t u r a l g a s . T h i s t a x p r o v i s i o n is c r i t i c a l i n h e l p i n g c a p i t a l - i n t e n s i v e i n d u s t r i e s l i k e O i l a n d N a t u r a l G a s t o r a i s e m o n e y n e c e s s a r y to k e e p d r i l l i n g .

I D C s are a p p r o x i m a t e l y 8 0 % o f t h e t o t a l cost o f t h e i n v e s t m e n t .

F U L L E X P E N S I N G O F T A N G I B L E D R I L L I N G COSTS ( T D O T h i s p r o v i s i o n is a s i g n i f i c a n t b e n e f i t b e c a u s e t h e o i l a n d gas i n d u s t r y is v e r y capital intensive.

T a n g i b l e d r i l l i n g c o s t s , l e a s e a n d w e l l e q u i p m e n t , p i p e l i n e s , a n d all o t h e r t a n g i b l e p e r s o n a l p r o p e r t y c a n be f u l l y d e d u c t e d w h e n a c q u i r e d a n d p l a c e d i n s e r v i c e .

T D C s are a p p r o x i m a t e l y 2 0 % o f the t o t a l cost of the i n v e s t m e n t a n d n o w 1 0 0 % d e d u c t i b l e in the y e a r of investment.

U t i l i z i n g t h e s e d e d u c t i o n s c a n r e s u l ti n u p t o h a l f o f y o u r d r i l l i n gi n v e s t m e n t b e i n g f u n d e d b y y o u r tax savings.

PERCENTAGE D E P L E T I O N D E D U C T I O N IS R E T A I N E D D e p l e t i o n a p p l i e s w h e n p r o d u c t i o n b e g i n s , a n d it a l l o w s t h e o w n e r o f a p r o d u c i n g

o i l a n d o r n a t u r a l gas w e l l t o r e c o v e r t h e i r i n v e s t m e n t t h r o u g h t a x d e d u c t i o n s o v e r t h e p e r i o d i n w h i c h oil a n d o r g a s is p r o d u c e d .

T h e d e p l e t i o n d e d u c t i o n i s 15% o f gross i n c o m e f o r the life o f t h e well. ?

Royace ENERGY, INC.

Table of Contents I. Explanations of the Tax Advantages A. The Tax Cut and Job Act ................................................................... 1 B. Reducing Federal and State Income Taxes ............................................. 6

C. Active vs. Passive lncome .................................................................... 6 D. Intangible Drilling Costs ....................................................................... 6 E. Tangible Drilling Costs ........................................................................ 6 F. Depletion . ........................................................................................ .6

II. Sample Tax Letters from Royale Energy, Inc. A. Sample Schedule C Tax Deduction Letter.............................................. 9 B. Sample 1099 Letter ................................................... ..................... .. 10

C.

Sample Miscellaneous Income Letter.................................................. . 11

Ill. Two Tax Return Examples A. Example #1: New Jnvestor ................................................................. 14 1. Schedule C (Form 1040) .......................................................... 15 2. Depreciation and Amortization (Form 4562) ................................. 17 B. Example #2: Existing Investor...................................................... .... . .20 1. Schedule C (Form 1040) .......................................................... 21

IV.Supplemental Documentation Materials A. Business Expenses ......................................................................... .25 1. Costs You Can Deduct or Capitalize ........................................... 26 2. Intangible Drilling Costs ............................................................ 26 3. Depletion .............................................................................. 26 B. US Tax Code, Section 469.c.3 ............................................................ 28 C. US Tax Code, Section 263 ................................................................. 29

Risk Disclosure Statement This guide provides examples of the tax advantages of Oil & Gas exploration. Each individual has a unique tax situation. Royale Energy and its employees are not licensed to give any tax advice. Investors considering purchasing Oil & Gas interest should consult their tax advisor and legal counsel to evaluate any tax benefits. Cash flows and returns are not guaranteed and may be lower than anticipated. Past performance is no guarantee of future results.

No statement within the guide should be construed as an offer to buy or sell a security. Investments in Oil & Gas involve a substantial degree of risk and are not suitable for all investors. A prospectus, private placement memorandum, or contract should be read thoroughly and understood before investing. Per Section 501 of Regulation D, Oil & Gas investments are typically suitable only for accredited investors.

Explanations of the Tax Advantages

Forbes

T H E FINAL TRUMP T A X BILL: A CLEAR N E T POSITIVE F O R U . S . OIL AND GAS D. Blackmon - December 21, 2017

So, for the oil and natural gas industry, what is the impact of the new tax bill just passed by congress? As for most other American businesses, the bill is a mixed bag of lowered tax rates and limited deductions, but at the end of the day, it appears to be a net positive.

Here's why: • Tax Rates are lowered - This one's rather obvious. Lowering the corporate rate from 35% to 21 %, and lowering all personal marginal rates will clearly benefit everyone involved in the oil and gas industry from a tax standpoint. Not much more needs to be said there.

• The option to expense Intangible Drilling Costs is retained - This century-old tax treatment was the number one issue for the upstream independents who produce the lion's share of oil and gas in the U.S. today. The industry's lobby and upstream trade associations have worked overtime for the last eight years to educate members of congress about how critical this tax provision is to the ability of this very capital-intensive industry to raise the capital necessary to keep drilling . Those efforts paid off in the end, as this key provision was retained in the final bill.

• A new provision allows the expensing of some additional capital investments - The bill allows businesses to expense the full cost of new investments in certain plant and equipment for the next five years, and then gradually phases this provision out. This will benefit many in the upstream, midstream and downstream sectors of the oil and gas industry.

• Percentage Depletion deduction is retained - Another century-old tax treatment, this one is important to small independents and royalty owners.

• Corporate Alternative Minimum Tax (AMT) is repealed - No one in the oil and gas industry or any other business sector will mourn the passing of this provision, which has served mainly to penalize marginally profitable corporations for decades. This repeal is a real positive development for rapidly expanding midstream companies as well as many upstream producers.

• Personal AMT is retained, scaled back - Another positive development for privately-held businesses and royalty owners. My only complaint is that this inherently un-American concept wasn't repealed for individuals as it was for corporations. We can thank the goofy congressional "scoring" rubrick for that discrepancy.

PART III-COST RECOVERY AND ACCOUNTING METHODS Subpart A-Cost Recovery

SEC. 13201. TEMPORARY JOO-PERCENT EXPENSING FOR CERTAIN BUSINESS ASSETS. (a) INCREASED EXPENSING.(1) IN GENERAL.-Section 168(k) is amended-

(A) in paragraph ( l )(A), by striking "50 percent" and inserting "the percentage", and applicable (B) in paragraph (5)(A)(i), by striking "50 percent" and inserting "the applicable percentage".

(2) APPLICABLE PERCENTAGE.-Paragraph (6) of section 168(k) is amended to read as follows: "(6) APPLICABLE PERCENTAGE.-For purposes ofthis subsection"(A) IN GENERAL-Except as otherwise provided in this paragraph, the term 'applicable percentage' means"(i) in the case of property placed in service after September 27, 2017, and before January I, 2023, I00 percent, "(ii) in the case of property placed in service after December 31, 2022, and before January I, 2024, 80 percent, "(iii) in the case of property placed in service after December 31, 2023, and before January I, 2025, 60 percent, "(iv) in the case of property placed in service after December 31. 2024, and before January I, 2026, 40 percent, and

2

T A X CUTS AND JOBS A C T CHANGES FOR TAXPAYERS IN T H E NEW T A X LAW The Tax Cuts and J o b s Act (TCJA) outlines many changes for taxpayers in the oil and gas industry.

The T C J A generally lowers income tax rates for individual taxpayers, significantly reduces the income tax rate for corporations, and eliminates the corporate alternative minimum tax (AMT). It also provides a large new tax deduction for most owners of pass-through entities and significantly increases individual AMT and estate tax exemptions.

Taxpayers in the oil and gas industry are affected because they hold their assets and investments in a variety of entity types, including C corporations, partnerships, S corporations, and directly by individuals.

The T C J A also eliminates or limits many tax breaks. The key changes that affect taxpayers in the oil and gas industry are outlined below.

• Immediate expensing (also referred to as Bonus Depreciation) • Enhanced Section 179 deprecation

Full Expensing of Tangible Property

This provision could be a significant benefit because the oil and gas industry is very capital intensive.

Tangible drilling costs, lease and well equipment, pipelines, and all other tangible personal property can be fully deducted when acquired and placed in service after September 27, 2017, and before January 1, 2023. The full deduction is phased down by 20% each year in taxable years beginning on or after January 1, 2023: 2023-80%

2024-60% 2025-40%

2026-20%

2027-0%

The new tax law also permits used property to be eligible for the full expensing provision.

This change may impact merger and acquisition transactions by motivating buyers to structure deals as actual or deemed asset acquisitions rather than stock acquisitions. This is accomplished by enabling the buyer to immediately deduct a significant portion of the purchase price and generate NO Ls in the year of purchase to offset future taxable income.

Enhanced Section 179 Depreciation

The popular Section 179 deduction has been increased from $ 5 0 0 ,0 0 0 to $1 million with the phase-out limitation increasing from $2 million to $2.5 million for tax years beginning after December 31, 2017. These amounts are indexed for inflation for years beginning after 2 0 18 . The Section 179 deduction applies to tangible personal property such as machinery and equipment which is purchased for use in a trade or business.

Repeal of Corporate AMT

The repeal of AMT for corporations is favorable for the oil and gas industry. In addition to taxpayers being able to fully deduct tangible drilling costs a s explained above, corporate taxpayers will now be able to fully deduct intangible drilling costs without a potential preference for AMT purposes. Integrated oil and gas corporations would still be required to capitalize 30%of those costs ratably over a 60-month period beginning in the month in which they were incurred.

For mining companies, taxpayers were generally limited to only cost depletion for AMT purposes even though for regular tax purpose they were allowed the higher of cost or percentage depletion. Historically, a lot of mining companies have been in an AMT position due to the preference for percentage depletion.

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REDUCING FEDERAL AND STATE INCOME TAXES

The U.S. government has provided tax incentives to stimulate do1:1estic oil and natural gas production financed by private investors. Oil and natural gas proJects offer many tax advantages. These tax benefits enhance the economics of oil and natural gas projects.

ACTIVE V s . PASSIVE INCOME

The Tax Reform Act of 1986 introduced into the Tax Code the concepts of "Passive" income and "Active" income. The Act prohibits the offsetting of losses from Passive activities against income from Active businesses. The new Tax Code specifically states that a Working Interest in an oil and gas well is not a "Passive" activity; therefore, deductions can be offset against income from active stock trades, business income, salaries, etc.

Use money you would otherwise pay out to federal and state income taxes to build a portfolio in energy.

INTANGIBLE DRILLING COSTS ( I D C ' s )

Intangible Drilling Costs are the labor and supplies incidental that are necessary for the drilling and preparation of the well for production of oil and gas. This is approximately 80% of the total cost of the investment and 100% deductible in the year of investment.

IDC's are placed on Schedule C/Form 1040 (Profit or Loss from Business) in Part V (Other Expenses) on line 48.

Additional information on the US Tax Code, Section 263.

TANGIBLE DRILLING COSTS ( T D C ' s )

TDC's are approximately 20% of the total cost of the investment. Tangible drilling costs, lease and well equipment, pipelines and all other tangible personal property can be fully deducted when acquired and placed in service after September 27, 2017 and before January 1, 2023.

100% of the TDC's can be deducted in the year of investment.

TDC's are placed on Form 4562 (Depreciation and Amortization).

DEPLETION

Depletion applies when production begins, and it allows the owner of a producing oil and/ or gas well to recover their investment through tax deductions over the period in which oil and/ or gas in produced. The depletion deduction is 15% of gross income for the life of the well. The deduction is placed on line 12 of Schedule C/Form 1040.

For example, $11,000 in gross income depleted at 15% is $1650 and is placed on line 12 of the Schedule C/Form 1040.

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Sample Tax Letters from Royale Energy, Inc.

Sample Schedule C Tax Deduction Letter Royale Energy Inc. 1870 Cordell Ct., Suite 210 El Cajon, Ct\ 92020 619-383-6600

Note: This letter will be sent to you to document your deductions.

A K-1 is not needed.

January 30, 2019 John & Jane Oil 1234 Royale Street San Diego, CA 92108 Owner ID:##### RE: Schedule C Information Dear Mr. & Mrs. Oil:

The amount listed below should be used in reporting your oil and natural gas activities associated with Royale Energy, Inc. in your respective tax returns for 2018. These amounts should be included in Schedule "C" profit or (loss) from business or profession on Form 1040.

These amounts are NOT reported as a partnership income or (loss) on Schedule "E" of Form

1040.

Intangible Drilling and Development Costs are all expenditures made by an operator for wages, fuel, supplies, etc., inclusive to and necessary for the drilling and preparation of wells for the production of oil and natural gas, including costs incurred to purchase and install well equipment during the development of the well.

Intangible Drilling Costs:

$40,000

Tangible Well Equipment:

$10,000

There are various tax treatments and elections that are accorded to oil and natural gas activities. We are not licensed to advise you regarding your taxes and we strongly recommend that you consult with your tax preparer/accountant as to your individual tax needs. ff you have any questions or need additional assistance, please contact our Investor Relations Department at 619-383-6600.

Sincerely yours,

Ronald Lipnick Controller

Sample 1099 Tax Deduction Letter Royale Energy Inc. 1870 Cordell Ct., Suite 210 E l Cajon, C A 92020 (619) 383-6600

January 30, 2019 John & Jane Oil 1234 Royale Street San Diego, CA 92108

NOTE:This is one of the two letters you will receive to document your income yearly

Owner ID: ####### Dear Mr. & Mrs. Oil: The amount listed below should be used in reporting your oil and gas activities associated with Royale Energy, Inc. in your respective tax returns for 2018. These amounts should be included in Schedule "C" profit or (loss) from business or profession on Form 1040. These amounts are NOT reported as a partnership income or (loss) on Schedule "E" of Form 1040.

Oil and Gas Revenue:

$11,000

Less Operating Expenses:

$1,500

Less Production Tax:

$0

FORM 1099

NOTE: The Oil&Gas Revenue is gross Your dollars. actual Paid Income is 11,000 - $1,500 = $9,500.

The 1099 you received shows the Gross Revenue you received during 2018. This will not match the amounts of your revenue checks. Lease operation costs and production taxes were deducted from the gross revenue, so the checks show all revenues, tID<es and expenses associated with your interest in production.

We hope this will be helpful regarding the information that you may desire to give to your tax preparer/accountant.

If you have any questions or need additional assistance, please contact our Investor Relations Department at 619-383-6600.

Sincerely yours,

Ronald Lipnick Controller

10

Sam le Miscellaneous Income Letter Royale Energy Inc. 1870 Cordell Ct., Suite 210 El Cajon, CA 92020 (619) 383-6600

January 30, 2019

NOTE: This is one of two letters you will receive to document your yearly income.

RECIPIENT TAX ID: #l#t # # #### OWNER ID:##### John & Jane Oil 1234 Royale Street San Diego, CA 92108

2018 STATEMENT FOR RECIPIENTS OF MISCELLANEOUS INCOME FORM 1099 - MISC 0MB No. 1545-0115 The following is important Tax Information and is being furnished to the Internal Revenue Service. If you are required to file a return, a negligence penalty or other sanction will be imposed on you if taxable income results from this transaction and the IRS determines that it has not been reported.

Federal regulations require that we report Gross Earnings to the IRS. For your information the following includes the net amount paid to you.

2. Ro alties $0

4. Fed W/H $0

11. State W/H $0

Prod.IT axes $0

Deductions $0

Net $11,000

INSTRUCTIONS FOR RECIPIENTS OF MISCELLANEOUS INCOME: The amounts shown on this form may be subject to self-employment tax. If your net earnings from self-employment income are $400.00 or more, you are required to file a return and compute your self-employment tax on Schedule SE (Form 1040). See Pub. 533, Self-Employment Tax. If no income or social security and Medicare taxes were withheld by the payer, you may have to make estimated tax payments if you are still receiving these payments. See Form 1040ES Estimated Tax for Individuals. If you are an individual, report the taxable amounts on your tax return as shown below. Others, such as corporations or partnerships, report the amounts on the proper line of your tax return.

Item 1 & 2: Report rents from real estate On Schedule E (1040), if you sold real estate as a business, or rented personal property as a business, report on Schedule C or C-EZ (Form 1040). For royalties on timber, coal, and iron ore, see Pub. 544, 'Sales and Other Dispositions of Assets'.

Item 4: Shows backup withholding. For example, persons not furnishing their taxpayer identification number to the payer become subject to backup withholding at 31 % rate on certain payments. See Form W-9, Request for Tax-payer Identification Number and Certification, for information on backup withholding. INCLUDE THIS AMOUNT ON YOUR INCOME TAX RETURN AS TAX WITHHELD. Item 7: Generally, these amounts are considered income from self-employment. Since you received this form, rather than Form W-2, the payer may have considered you self-employed and did not withhold social security or Medicare taxes. Report self-employment income on Schedule C, C-EZ, or F (Form 1040), and compute the self-employment tax on Schedule SE (Form 1040). If you are not selfemployed, report this amount on the 'Wages, salaries, tips, etc.' line of Form 1040. Call the IRS for information about how to report any social security and Medicare Taxes.

Two Tax Return Examples

12

E x a m p l e #1 (New I n v e s t o r ) T h e f o l l o w i n g t a x r e t u r n e x a m p l e is f o r a n e w i n v e s t o r w i t h Royale E n e r g y , I n c . A t this p o i n t t h e y have no established income b u t because of The Tax C u t a n d J o b s A c t (TCJA) t h e y are a b l e t o q u a l i f y f o r t h e s e c t i o n 179 e l e c t i o n . T h e y w i l l d e d u c t 8 0 % o f t h e i r i n v e s t m e n t as i n t a n g i b l e d r i l l i n g c o s t s p l u s t h e r e m a i n i n g 2 0 % o f t h e i r i n v e s t m e n t as tangible d r i l l i n g costs i n the first year.

A S S U M P T I O N S U S E D IN A L L T w o T A X R E T U R N E X A M P L E S >

Based on Using % Unit Example of a $50,000 Investment

>

Schedule C Letter 1. T o t a l I n v e s t e d D o l l a r s : $ 5 0 , 0 0 0 2. I n t a n g i b l e D r i l l i n g C o s t s : $ 4 0 , 0 0 0 ( 8 0 % o f I n v e s t e d D o l l a r s ) 3. T a n g i b l e W e l l E q u i p m e n t : $ 1 0 , 0 0 0 ( 2 0 % o f I n v e s t e d D o l l a r s )

>

1099 Income Statement 1. G r o s s O i l a n d G a s Revenue: $ 1 1 , 0 0 0 2. W e l l O p e r a t i n g E x p e n s e s : $ 1 , 5 0 0

E X P L A N A T I O N OF THE STEPS USED S c h e d u l e C (Form 1040):

1. L i n e 13 - D e p r e c i a t i o n d e d u c t i o n : $ 1 0 , 0 0 0

2. L i n e 4 8 - I n t a n g i b l e d r i l l i n g costs: $ 5 0 , 0 0 0 x 8 0 % = $ 4 0 , 0 0 0 ( I n t a n g i b l e D r i l l i n g C o s t s = I n v e s t m e n t x 80%) 3.

Line 2 7 - A m o u n t calculated in line 48: $40,000

.

Line 2 8 ? A d d lines 8 t h r o u g h 27: $ 1 0 , 0 0 0 + $ 4 0 , 0 0 0 = $ 5 0 , 0 0 0

.

L i n e 2 9 ? S u b t r a c t l i n e 2 8 f r o m l i n e 7: $ 0 - $ 5 0 , 0 0 0 = ( $ 5 0 , 0 0 0 ) Note: ( ) a r e u s e d to d e n o t e a n e g a t i v e n u m b e r .

6. L i n e 31 ? S u b t r a c t l i n e 3 0 f r o m l i n e 29: ( $ 5 0 , 0 0 0 ) - $ 0 = ( $ 5 0 , 0 0 0 ) F o r m 4562:

1. L i n e 2 - T o t a l c o s t o f s e c t i o n 179: $ 1 0 , 0 0 0

2. L i n e 8 - T o t a l elected c o s t o f s e c t i o n 179 p r o p e r t y : $ 1 0 , 0 0 0 3. L i n e 9 - T e n t a t i v e d e d u c t i o n : $ 1 0 , 0 0 0 4,

Line 10 ? Carryover of disallowed deduction: $ 0

5 . L i n e 12 ? S e c t i o n 1 7 9 e x p e n s e d e d u c t i o n : $ 1 0 , 0 0 0 6. L i n e 22 - A d d lines 12, 1 4 - 1 7 , a n d 1 9 - 2 1 : $ 1 0 , 0 0 0

Form 4562

Example #1 (New Investor)

0 M B No. 1545-0172

Depreciation and Amortization

@18

( lncludlng lnfonnatlon on Listed Property) Attach to our tax return.

D e p a , t m n of the Trea,u,y ln1emal Revenue SeMoe

Name(s) shown on return

John & Jane 011 (1/2 Unit Investment ofSS0,000)

Attachment Sequence No. Identifying number

Business or activrty to which this form relates

Oil & Gas Extraction

179

Election To Expense Certain Property Under Section 179 Note: If you have any listed property, complete Part V before you complete Part I. 1 Maximum amount (see instructions) .

2 3 4 5 6

7 8 9 10 11 12 13

1

Total cost of section 179 property placed in service (see instructions) Threshold cost of section 179 property before reduction in limitation (see instructions) Reduction in limitation. Subtract line 3 from line 2. If zero or less, enter -0Dollar limitation for tax year. Subtract line 4 from line 1. If zero or less, enter -0-. If married filing separately, see instructions (a) Description of property

(b) Cost (business use only)

S10 000

2

3

4 5

(c) Elected cost

I

Listed property. Enter the amount from line 29 7 Total elected cost of section 179 property. Add amounts in column (c), lines 6 and 7 Tentative deduction. Enter the smaller of line 5 or line 8 Carryover of disallowed deduction from line 13 of your 2016 Form 4562 .

Business income limitation. Enter the smaller of business income (not less than zero) or line 5 (see instructions) Section 179 expense deduction. Add lines 9 and 10, but don't enter more than line 11 Carryover of disallowed deduction to 2018. Add lines 9 and 10, less line 12 ►

I 13I

II

8 9 10 11 12

SI0,000 SI0.000

so

Sl0,000

Special Depreciation Allowance and Other Depreciation (Don't include listed prope . (See instructions.)

14 Special depreciation allowance for qualified property (other than listed property) placed in service during the tax year (see instructions) 14 i r - - - - - - r---15 15 Property subject to section 168(f)(1) election . . . . . . . . . . . . . . .

-t. . . . . . . . . . . . . . . . . t--1-6 - - - - - Other de reciation includin ACRS MACRS Depreciation (Don't include listed prope .) (See instructions.)

Section A 17 MACRS deductions for assets placed in service in tax years beginning before 2017 . . . . . . .

17 I - -- - - J'---- - - - - 18 If you are electing to group any assets placed in service during the tax year into one or more general asset accounts, check here . . . . . . . . . . . . . . . . . . . . . .

Section B - A s s e t s Placed in Service During 2017 Tax Year Using the General Depreciation System

□

(a) Classification of property

(b) Month Md year placed in service

(c) Basis for depreciation (business/investment use

only-see Instructions)

(d) Recovery period

(e) Convention

(f) Method

(g) Depreciation deduction

19a b

3-year property 5-year property C 7-year property d 10-year property e 15-vear property f 20-year property 25yrs.

S/L Q 25-year property 27.5yrs.

MM h Residential rental S/L property 27.5 yrs.

MM S/L 39yrs.

MM i Nonresidential real S/L property MM S/L Section C-Assets Placed in Service DurinQ 2017 Tax Year UsinQ the Alternative Depreciation Svstem SIL 20a Class life 12yrs. b 12-vear S/L 40yrs.

MM c 40-vear S/L .

Summary (See instructions.} 21 Listed property. Enter amount from line 28 21 22 Total. Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21. Enter here and on the appropriate lines of your return. Partnerships and S corporations-see instructions 22 S10 000 23 For assets shown above and placed in service during the current year, enter the portion of the basis attributable to section 263A costs . . . . . . .

23 __.: ...

I I

- ..

.

I

Example #1 (New Investor) 4

Fr

SCHEDULE C (Form 1040)

P r o f i t or L o s s F r o m B u s i n e s s

OMB No. 1845-0074

(Sole Proprietorship)

2QO 1 8 and the latest information.

» Go to www.irs.gov/ScheduleC for instructions

Department of the Treasury intemal Revenue Service (99)

> A t t a c h t o F o r m 1040, 1040NR, o r 1041; p a r t n e r s h i p s g e n e r a l l y m u s t f i l e F o r m 1066.

Sequence No. 0 9

S o c i a l security n u m b e r (SSN)

Name of proprietor

000-00-0000

J o h n & Jane O i l ( 1 / 2 U n i t I n v e s t m e n t o f $ 5 0 , 0 0 0 ) A

Attachment

Principal business or profession, including product or service (see instructions) O i l & Gas Extraction Business name.

If

©

no separate business name, leave blank.

E m p l o y e r ID n u m b e r (EIN) (see instr.) i

R o y a l e Energy, Inc. E

Business address {including suite or room no.) ® town or

City,

post

1870 C o r d e l l C t . , Suite 210. ennneneeveeeceeeenenaneueeenennnnnenececnnccennerennennene

office, state, and ZIP c o d e

E l Cajon, CA. 9 2 0 2 0

F a H i

(1) [JCash Accounting method: (2) [JAccrual (3) [ O t h e r (specify) > ceeennrne eene mene Did you ?materially participate? in the operation of this business during 2018? If ?No,? see instructions for limit on losses. [ X i Yes [ J N o If youstartedo r a c qt h i us businessduring i r e d 2018, check h e r e . . . toe e e ee > O make any payments in 2018 D i d you that would require you to file Form(s) 40997(eee instructions) . ee ee EYes [ N o

J

I f ?Yes,? didyouo r will

ew

u a e

fila requiredForms 1 0 9 9 7 .

you

=»

=.

| . . .

Y e s

FINO

Income Gross receipts or sales. See instructions for line 1 and check the box if this income was reported to you on . . . .

Form W-2a n d t h e ?Statutory employes? box on t h a t f o r m w a s c h e c k e d . . .

- P oO

1

|

s

d 00

2.

= Retums and allowances

2 3

_ 2 |

.

[ [

4

Subtract line 2 from line 1 Cost of goods sold (from line 42)

8

Gross profit. Subtract line 4 f r o m l i n e 3

&

Other income, including federal and state gasoline or fuel tax credit orrefund (see instructions).

7

__Grossincome. Addlines5and6

agin

Advertising.

9

C a r a n d t r u c k e x p e n s e s (see

.

.

.

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14

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b

Employee benefit programs (other than on line 19).

Insurance (other than health)

16

i n t e r e s t (see i n s t r u c t i o n s ) : a

a

(eee

18

.

|

7

Office expense (see instructions)

l

Pension and profit-sharing plans

[ w l

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w

]

s s

Other business property

Supplies (not included in Part i l l ) .

23

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| 1 5|

.

.

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i .

o

25 26

: «Utilities W a g e s ( l e s s e m p l o y m e n tc r e d i t s )

27a

O t h e r e x p e n s e s ( f r o m line 48) .

17

__Legalandprofessionals ervices

28

Total e x p e n s e s before expenses for business use of home. A d d l i n e s 8through27a .

29

Tentative profit or (loss). Subtract line 28 f r o m l i n e 7 .

2 . . .

Expenses for business use of your home. Do not report these expenses elsewhere. Attach Form9 8 2 9

30s

s

@ |]?

on Tne3 0 .

Repairs a n d maintenance

a b

ti??SCsdLSCSCS*St

[

> f

22 =

a

| 46b| f a z ]

.

21

24

M o r t g a g e (paid t o banks, etc.)

b O t h e .

.

/ ]

2 0 ~?- R e n t o r l e a s e (see i n s t r u c t i o n s ) : _ f F a Vehicles, machinery, a n d e q u i p m e n t | 2 0 a |

[ 1 1 ]|

Depletion . .

D e p r e c i a t i o n a n d s e c t i o n 179 expense

ee

.

_.

..

i

.

instructions), 2 .

1 .

Commissions andfees

14

.

E x p e n s e s . Enter expenses f o rb u s i n e s s useo f o u r h o m e on

8

10

.

3 4

Reserved f o r f u t u r e use .

.

.

|

.

E A

. . .

l

l e o

($40,000/00) f~

S s ( l r d | CY

| 28|

1

$50,000

100

v0

unless using the simplified method (see instructions).

Simplified m e t h o d filers only: enter the total square footage of: (a) your home: .

a n d (b) t h e p a r t o f y o u r h o m e u s e d f o r b u s i n e s s : M e t h o d W o r k s h e e t in t h e instructions t o figure t h e a m o u n t t o e n t e r o n l i n e 3 0 31?

.

.

Use the Simplified .

.

.

N e t p r o f i t o r ( l o s s ) . S u b t r a c t l i n e 3 0 f r o m line 29. ¢ If a profit, enter o n both S c h e d u l e 1 ( F o r m 1040), line 12 (or F o r m 1040NR, l i n e 13) and o n S c h e d u l e SE,

1

|

.

line 2. (If you checked the box on line 1, see instructions). Estates and trusts, enter on Form 1041, line 3, ©

32

~?sIf

Ifaioss, you must

$ 5 0 , 0 0 0| 00

go t o line 3 2 .

you have a loss, check the box that describes your investment in this activity (see instructions).

If you checked 32a, enter the loss on both Schedute 1 (Form 1040), line 12 (or Form 1040NR, line 13) and on S c h e d u l e SE, line 2. (If you checked the box on line 4, see the line 31 instructions).

32a [Q) All investment is at risk.

Estates and trusts, enter on Form 1041, line 3.

3 2 b [ ] Some investment is not

¢

©

If

you

checked 32b,

you

m u s t attach Form 6198. Your loss may be limited.

F o r P a p e r w o r k R e d u c t i o n A c t Notice, see the separate instructions.

at risk.

Cat. No. 11334P

S c h e d u l e C ( F o r m 1049) 2 0 1 8

Schedule C (Form 1040} 2 0 1 8

Eznw 3

2

C o s t of Goods Sold

(see instructions}

Mathod(s) used to value closing inventory:

34

a

()

Cost

b

(C]L o w e r o f

cost or market

c

[)

Other (attach explanation)

Was there any change in determining quantities, costs, or valuations between opening and closing inventory? {f"Yes,"attachexplanstion.

2 . . . w e t e e e e e e .

Inventory at beginning of year. If different from last year?s closing inventory, attach explanation

0 Y O

(1 N o

.

Purchases less cost o f items withdrawn for personal use C

oo f lsa b o t r . D o n o t i n c l u d e a n y a m o u n t s p a i d t oy o u r s e l f

.

Materials and supplies

Other c o s t s .

A d d l i n e s3 5 t h r o u g h

inventory at end of year

39.

.

Cost of g o o d s sold. Subtract line 41 from fine 40. Enter the result here and on line 4 . .

I n f o r m a t i o n o n Y o u r V e h i c l e . C o m p l e t e t h i s p a r t o n l y if y o u a r ec l a i m i n g ¢c a r o r t r u c k e x p e n s e s o n l i n e 9 a n d are n o t r e q u i r e d t o file F o r m 4 5 6 2 f o r t h i s b u s i n e s s . S e e t h e i n s t r u c t i o n s f o r line 1 3 t o f i n d o u t if y o u m u s t file F o r m 4562.

W h e n d i d y o u p l a c e y o u r v e h i c l ei n s e r v i c e f o r b u s i n e s s p u r p o s e s ? ( m o n t h , d a y , y e a r )

?Of

t h e t o t a l n u m b e r o f m i l e s y o u d r o v e y o u r v e h i c l e d u r i n g 2 0 1 8 , e n t e r t h e n u m b e r o f m i l e s y o u u s e d y o u r v e h i c l e for:

Business

Commuting (see instructions)

Was your vehicle available for personal use during off-dutyhours?

.

¢ Other 2.

Do you (or your spouse) have another vehicle available for personaluse?, 47a

ZL

Do you have evidence to support yourdeduction?

.

.

6

we

2 . . .

2.

2

1.

6

1

ee

if ?Yes,? is t h e evidence written? . .

O t h e r E x p e n s e s . L i s tb e l o w B u s i n e s s e x p e n s e sS n o t i n c l u d e d o nn i n e s e

48

T o t a l other expenses. Enter hereandonlins27a_.

w 6

e

e

ee e

.

ee

OVO

( J No

0

( J No

.

Yes Yo)

.

oO

Yes

No

=

O

No

6 - 2 6 or line 30.

| 48|

$40,000 S c h e d C (Form u l e 1040) 2018

om

Bsample HT(New

Terr

4562

Investor)

O M B No. 1545-0172

D e p r e c i a t i o n and A m o r t i z a t i o n

2018

(Including Information on Listed Property) > Attach to your tax return.

og

Attachment Sequence No. 1 7 9

Business or activity to which this form relates

Name(s) shown on retum

John & Jane O i l (1/2 U n i t I n v e s t m e n t of $50,000)

Identifying number

O i l & Gas E x t r a c t i o n

Election T o Expense Certain Property Under Section 179 N o t e : If y o u h a v e a n y listed property, c o m p l e t e Part V b e f o r e y o u c o m p l e t e Part Coe

M a x i m u m a m o u n t (see i n s t r u c t i o n s ) .

e

e

I. .

Total c o s t of s e c t i o n 1 7 9 p r o p e r t y p l a c e d in service (see i n s t r u c t i o n s )

toe

T h r e s h o l d c o s t o f s e c t i o n 1 7 9 p r o p e r t y before r e d u c t i o n i n limitation (see i n s t r u c t i o n s )

.

R e d u c t i o n in l i m i t a t i o n . S u b t r a c t line 3 f r o m line 2. If zero o r less, e n t e r - 0 - . woe e e ee D o l l a r l i m i t a t i o n f o r t a x year. S u b t r a c t line 4 f r o m line 1. If z e r o o r less, e n t e r -0-. If m a r r i e d filing separately, seeinstructions

.

2 . . . )

)

ee

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lf .

7 Listed property. Enter the amount f r o m l i n e 2 9 . .

.

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l

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.

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.

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8 Total elected cost of section 179 property. Add amounts in column (c), lines 6 and 7 9 Tentative deduction. Enter the smaller of l i n e 5 o r l i n e 8 2 2 . ee ee ee 40 Carryover of disallowed deduction from line 13 of your 2016 Form 4562 .

Soe e e e 41. Business income limitation. Enter the smaller of business income (not less than zero) or line 5 (see instructions) 2

12 Section 179 expense deduction. Add lines 9 and 10, but don?t enter more than line 1 1 .

13 Carryover of disallowed deduction to 2018, Add lines 9 and 10, less line 12_ > Note: Don?t use Part I or Part Ill below for listed property. instead, use Part V. S p e c i a l D e p r e c i a t i o n A l l o w a n c e a n d O t h e r D e p r e c i a t i o n ( D o n ' t include listed prope 14 Special depreciation allowance for qualified property (other than listed property) placed in service during the tax year (see instructions) ry 45 Property subject to section 168(f}(1) election . . . . .

46 Other depreciation (including ACRS) E 2 P S e M A C R S D e p r e c i a t i o n ( D o n ' t include listed property.) (See instructions.)

Section A 2.

17 MACRS deductions for assets placed in service in tax years beginning before2017..

2... 1 .

18 If you are electing to group any assets placed in service during the tax year into one or more general ff a s s e t accounts, checkhere . 6 . ee . ?

Section B ? A s s e t s Placed in Service During 2017 Tax Year Using the General DepreciationS y s t e m

(a) Classification of property

(b)M o dand year] service

Basis iness/investment for depreciation u s e | (4) Recovery | only?see instructions) period

?(c)

(@)

Convention

() Method

3-year prope 5-year prope c_ 7-year propel d 10-year prope e 15-year propel f 20-year prope

19a

b

g 25-year prope! h Residential rental [ |

property r TNonresidential reall property

ere

d MM

Section C ? A s s e t s Plac: 20a Class life

iZaasha

g

9

S/L 5

ES

S u m m a r y (See instructions.)

.

21 Listed property. Enter amount f r o m l i n e 2 8 ee 22 Total. Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21. Enter 6

6

6

h e r e a n d on t h e a p p r o p r i a t e lines of y o u r return. P a r t n e r s h i p s a n d S c o r p o r a t i?osne es i n s t r u c t i o n s 23

For a s s e t s s h o w n a b o v e a n d p l a c e d in s e r v i c e d u r i n g t h e c u r r e n t year, e n t e r t h e portion of t h e b a s i s a t t r i b u t a b l e to s e c t i o n 2 6 3 A c o s t s

iti

(9) Depreciation deduction

Form 4562

Page 2

L i s t e d P r o p e r t y ( I n c l u d e a u t o m o b i l e s , c e r t a i n o t h e r vehicles, c e r t a i n aircraft, c e r t a i n c o m p u t e r s , a n d p r o p e r t y used for entertainment, recreation, or amusement.)

N o t e : For a n y v e h i c l e for w h i c h y o u are u s i n g t h e s t a n d a r d miteage r a t e or d e d u c t i n g lease e x p e n s e , c o m p l e t e o n l y 24a, 24b, c o l u m n s (a) t h r o u g h (c) of S e c t i o n A, all of Section B, a n d SectionC i f applicable.

S e c t i o n A ? D e p r e c i a t i o n a n d O t h e r I n f o r m a t i o n ( C a u t i o n : See t h e i n s t r u c t i o n s for limits f o r p a s s e n g e r a u t o m o b i l e s .

2 4 a Do you have evidence to support the business/investment use claimed?

(0)

®)

is

of property (list| Dat yee chiles first)th nie Dieced investment u: percentage

Type

25

[ ] Y e s ] No |

t o r seorech id) Basis for depreciation Cost or other basis | (business/investment

{) Business/

use only)

24b

If?Yes,? is the evidence written? ( 1 Yes [_] No

o

ta)

0]

ponies

S p e c i a l d e p r e c i a t i o n a l l o w a n c e f o r qualified listed property p l a c e d in service d u r i n g t h e tax year a n d u s e d m o r e t h a n 5 0 % in a q u a l i f i e d business u s e (see instructions) .

P r o p e r t y u s e d m o r e t h a n 5 0 % in a qualified business use:

26

%

27

P r o p e r t y u s e d 5 0 % o r less in a q u a l i f i e d business use:

S e c t i o n B ? I n f o r m a t i o n o n U s e o fV e h i c l e s Complete this section for vehicles used b y a sole proprietor, partner, or other ?more than 5 % owner,? or related person. If you provided vehicles t o your employees, first answer t h e questions in Section C to see if you meet an exception to completing this section for t h o s e vehicles.

30

Total business/investment miles driven during the year (don?t include commuting miles)

31 32

>

Total commuting miles driven during the year

33

Total other personal ( n o n c o m m u t i n g } m i l e s driven Total m i l e s driven d u r i n g t h e year. ?Add

34

. l i n e s 30 t h r o u g h 3 2 W a s t h e v e h i c l e a v a i l a b l e for p e r s o n a l

use d u r i n g o f f - d u t y h o u r s .?

35

oo

W a s the v e h i c l e u s e d p r i m a r i l y b y a m o r e than 5 % o w n e r or r e l a t e d p e r s o n ?

36 S e c t i o n C ? Q u e s t i o n s f o r Employers W h o Provide Vehicles f o r Use b y Their Employees A n s w e r t h e s e q u e s t i o n s to d e t e r m i n e if you m e e t an e x c e p t i o n to c o m p l e t i n g S e c t i o n B for v e h i c l e s u s e d b y e m p l o y e e s w h o a r e n ' t m o r e t h a n 5 % o w n e r s o r r e l a t e d p e r s o n s (see instructions).

37

D o y o u maintain a w r i t t e n p o l i c y s t a t e m e n t that P r o h i b i t s a l t P e r s o n a l use o f vehicles, Inckiding c o m m u t i n g , y o u r e m p l o y e e s .?

Do y o u maintain a w r i t t e n p o l i c y? s t a t e m e n t t h a t p r o h i b i t s personal use o f vehicles, ?except commuting, b y : y o u r an

38

e m p l o y e e s ? See t h e i n s t r u c t i o n s f o r v e h i c l e s u s e d b y c o r p o r a t e officers, directors, or 1 % o r m o r e o w n e r s 39 40

D o y o u treat all use o f v e h i c l e s b y e m p l o y e e s as p e r s o n a l u s e ?

D o y o u p r o v i d e m o r e t h a n f i v e v e h i c l e s to y o u r e m p l o y e e s , o b t a i n information f r o m your ?employees a b o u t

41

. use o f t h e vehicles, a n d retain t h e i n f o r m a t i o n r e c e i v e d.?

D o y o u m e e t t h e r e q u i r e m e n t s c o n c e r n i n g q u a l i f i e d a u t o m o b i l ed e m o n s t r a t i o n? u s e ? (See I n s t r u c t i o n s . )

N o t e : If

the

w e e

your a n s w e r t o 3 7 , 38, 3 9 , 40, o r 41 Is ?Yes,? d o n ' t c o m p l e t e S e c t i o n B f o r t h e c o v e r e d vehicles.

Amortization (°) Description of costs

{b) Date amortization

{c) Amortizable amount

43

A m o r t i z a t i o n of c o s t s t h a t b e g a n before y o u r 2 0 1 7 t a x y e a r

44

T o t a l . A d d a m o u n t s in c o l u m n

(f).

.

:

S e e t h e i n s t r u c t i o n s for w h e r e to re| Form 4 5 6 2

(This page has been intentionally l e f t blank.)

E x a m p l e #2 (Existing Investor) T h e f o l l o w i n g t a x r e t u r n e x a m p l e is for a n e x i s t i n g i n v e s t o r i n t h e s e c o n d y e a r w i t h Royale E n e r g y , Inc. At t h i s p o i n t t h e y h a v e e s t a b l i s h e d i n c o m e a n d a r e a b l e to t a k e d e d u c t i o n s as follows.

1. D e p l e t i o n : 1 5 % o f G r o s s I n c o m e ( l i n e 1 2 ) 2. W e l l o p e r a t i n g e x p e n s e s ( l i n e 4 8 ) ASSUMPTIONS USED IN A L L THREE T A X RETURN EXAMPLES >

Based on Using % Unit Example of a $50,000 Investment

>

Schedule C Letter 1. T o t a l I n v e s t e d D o l l a r s : $ 5 0 , 0 0 0 2. I n t a n g i b l e D r i l l i n g C o s t s : $ 4 0 , 0 0 0 ( 8 0 % o f I n v e s t e d D o l l a r s ) 3. T a n g i b l e W e l l E q u i p m e n t : $ 1 0 , 0 0 0 ( 2 0 % o f I n v e s t e d D o l l a r s )

>

1099 Income Statement

1. G r o s s O i l a n d Gas Revenue: $ 1 1 , 0 0 0 2. W e l l O p e r a t i n g E x p e n s e s : $ 1 , 5 0 0

E x a m p l e #2 T a x R e t u r n S c h e d u l e C (Form 1040): 1. L i n e 7 - G r o s s o i l a n d g a s r e v e n u e : $ 1 1 , 0 0 0 2. L i n e 1 2 - D e p l e t i o n d e d u c t i o n : $ 1 1 , 0 0 0 x 1 5 % = $ 1 , 6 5 0 ( D e p l e t i o n D e d u c t i o n = G r o s s R e v e n u e x 15%)

3. Line 48 - Well operating expenses: $1,500 4. Line 27 ? A m o u n t calculated in line 48: $1,500 5. Line 28 - Add Lines 8 through 27: $1,650 +$ 1 , 5 0 0 = § 3 , 1 5 0 6.

Line 29 - S u b t r a c t line 2 8 f r o m line 7: $ 1 1 , 0 0 0 - $ 3 , 1 5 0 = $ 7 , 8 5 0 N o t e : ( } a r e u s e d to d e n o t e a n e g a t i v e n u m b e r .

7. L i n e 31 ? S u b t r a c t l i n e 29 f r o m l i n e 30: $ 7 , 8 5 0 - $ 0 = $ 7 , 8 5 0

" Example #2 (Existing I n v e s t o4r ) S C H E D ?

(Form 1040)

OMB No. 1545-0074

Profit or Loss From Business (Sole Proprietorship)

Q O 4 8

> Go to www.irs.gov/ScheduleC for instructions and the latest information.

Department of the Treasury

» A t t a c h t o F o r m 1 0 4 0 , 1 0 4 0 N R , o r 1041; p a r t n e r s h i p s g e n e r a l l y m u s t f i l e F o r m 1 0 6 5 .

Internal Revenue Service (99)

Sequence No. o 9

S o c i a l s e c u r i t y n u m b e r (SSN)

Name of proprietor

000-00-0000

J o h n & Jane O i l ( 1 / 2 U n i t I n v e s t m e n t o f $ 5 0 , 0 0 0 ) A

Attachment

Principal business or profession, including product or service (see instructions) O i l & Gas E x t r a c t i o n ©

Business name. If no separate business name, leave blank.

E m p l o y e r iD n u m b e r (EIN) (see instr.)

R o y a l e Energy, Inc.

City, town or

post

office, state, and ZIP c o d e

Accounting method:

F a

(1)

[X]Cash

Ei Cajon, C A 9 2 0 2 0

(2)

L.Accrual =

(JOther ( s p e c i f y ) >

(3)-:

D i d y o u ? m a t e r i a l l y p a r t i c i p a t e ? in t h e o p e r a t i o no f t h i s b u s i n e s s d u r i n g 2 0 1 8 7I f ?No,?s e ei

H

i f y o u started o r a c q u i r e d this b u s i n e s s d u r i n g 2018, c h e c k h e r e

2

©

-

7

-

7

n

e e

s

t

r fuo rcl i m t i ti o o n

e e

e e

in 2018 that would r e q you D i d y o u m aan y payments k e u it or f iel e Form(s) 10997 (seeinstructions).

I f ?Yes,? didyouo r will you file requiredForms 1 0 9 9 7 . . =...

I

J

=.

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.

.

.

s

losses.

[ x ] Y e s

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.

.

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Income

G r o s s r e c e i p t s o r s a l e s . S e e i n s t r u c t i o n s f o r l i n e 1 a n d c h e c k t h e b o x if t h i s i n c o m e w a s r e p o r t e d t o y o u o n .

F o r m W - 2 a n d the ?Statutory employee? b o x o n t h a t f o r m w a s c h e c k e d .

2 . .

- o

4

n

e e e

e t u m s . 2a . n 6 e d e ea e l l o ew a n e c e s . .

Gubtractline2fromline1 ee ee ee ee 4 ? C o s to f goodssold (from line42) L e e w e e ee e e e & G r o s s p r o f i t . S u bl i n te 4 rf r oa m l icn e 3t © ee ee 6 Other income, including federal andstate gasolineo r f utaxcredit e l orrefund (see instructions)

a $11,000}00

R

2 3

6

L B P $ 1 1 , 0 0 0 00 P a [ 5 s ]_ _ $ 1 1 , 0 0 0 / 0 0 | 6|

6

G r o s s i n c o m e . AddlinesS5and6. . . . . . - e e [Faas E x p e n s e s . Enter expenses for business use of your home o n l y on line 30.

8 Advertising. . . . - l s | | | 18 Office expense (see instructions) | 1 8| 7?

C a r and truck expenses (see instructions).

Commissions and fees l

9 10

C

o labor n t (see r instructions) a c t p .

Depletion . .

11

12 13

19

|

20 o i

] f

a

siz

as

b Other business property

Depreciation and section 179 (not expense deduction included in Part ill) (see instructions) . on

(other than online 19).

Insurance( o t h e r than health) Interest (see instructions): Mortgage (paid to banks, etc.)

a

b

Repairs and m a i n t e n a n c.e

22

S u p p l i e s (not i n c l u d e d i n P a r t I l l ) .

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24

.

16

21°

23 == Taxes and licenses .

ee

18

Pensionand profit-sharing plans L319| Raaea Rent or lease (see instructions): Vehicles, machinery, and equipment

a

Travel.

b

Deductible meais (see

w o e

instructions) . ti

25 = Utilities t o e ee 26 Wages (less employment credits) .

27a

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O t h e r e x p e n s e s ( f r o m line 48)

.

_Lagaland professional services

28 28

ib [ 1 7 ]s s s . S | Reserved for future use_. before expenses business use home.

Total expenses for of Addiines 8 through 2 7 a . . . ss Tentative profit or (loss). Subtract line 28 from line T o w ee

30

E x p e n s e s f o r b u s i n e s s use o f y o u r home. Do n o t report these e x p e n s e s elsewhere. A t t a c h F o r m 8 8 2 9

17

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u n l e s s u s i n g t h e s i m p l i f i e d m e t h o d (see i n s t r u c t i o n s ) .

S i m p l i f i e d m e t h o d f i l e r s o n l y : e n t e r t h e t o t a l s q u a r e f o o t a g e o f : (a) y o u r h o m e : a n d (b) t h e p a r t o f y o u r h o m e u s e d f o r b u s i n e s s :

.

M e t h o d W o r k s h e e t in t h e i n s t r u c t i o n s to f i g u r e the a m o u n t t o e n t e r o n l i n g 3 0 31

.

.

Use the Simptifiad 2 .

1

ew

N e t p r o f i t o r ( l o s s ) . S u b t r a c t l i n e 3 0 f r o m l i n e 29. ©

I f a profit, enter on both S c h e d u l e 1 ( F o r m 1040), line 1 2 (or F o r m 1040NR, line 13) a n d o n S c h e d u l e SE,

line 2. (If you c h e c k e d t h e box o n line 1, see instructions). Estates a n d trusts, enter o n F o r m 1041, line 3.

$7,850]

00

* I f a l o s s , you m u s t go to fine 32.

32

If you have a loss, check the box that describes your investment in this activity (see instructions). * I f y o u checked 32a, enter the loss on both Schedule 1 (Form 1040}, line 12 (or Form 1040NR, line 13) and on S c h e d u l e SE, line 2. {If you checked the box on line 1, see the fine 31 instructions).

Estates and trusts, enter on Form 1044, line 3. ®

If

you

checked 32b,

you

m u s t attach Form 6198. Your loss

may

For P a p e r w o r k Reduction Act Notice, see t h e s e p a r a t e instructions.

32a [X] Alt investment is at risk.

32b [ [ ] Some investment is not at risk.

be limited.

Cat. No. 11334P

Schedule

C

(Form 1040) 2018

Schedule C (Form 1040) 2018

E

w 3

P a g2e

C o s t o f G o o d s S o l d (see instructions)

_

M e t h o d ( s ) used to valuec l o s i n g inventory:

a

(

Cost

b

[7]L o w e r o f c o s t ormarket

c

[ J Other (attach explanation)

W a s t h e r e a n y c h a n g e in d e t e r m i n i n g q u a n t i t i e s , c o s t s , o r v a l u a t i o n s b e t w e e n o p e n i n g a n d c l o s i n g i n v e n t o r y ?

\f"Yes,?a t t a c h explanation

©

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6 OL

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.

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Other costs

.

lines 3 5 t h r o u g h 3 9

.

inventory at end of year

.

A d

C o s t o f g o o d s sold.

S u b t r a c t line 4 1 f r o m l i n e 40. E n t e r t h e r e s u l t h e r e a n d o n l i n e 4 .

i n f o r m a t i o n o n Y o u r V e h i c l e . C o m p l e t e this part o n l y if you arec l a i m i n g c a r o r t r u c k e x p e n s e s on line 9 ¢

a n d a r e n o t required t o file F o r m 4 5 6 2 f o r this business. See t h e instructions f o r line 13 t o find o u t if y o u m u s t file F o r m 4 5 6 2 .

W h e n d i d y o u p l a c e y o u r v e h i c l e i n s e r v i c e f o r b u s i n e s s p u r p o s e s ? ( m o n t h , d a y , year)

>

O f t h e t o t a l n u m b e r o f m i l e s y o u d r o v e y o u r v e h i c l e d u r i n g 2 0 1 8 , e n t e r t h e n u m b e r o f m i l e s y o u u s e d y o u r v e h i c l e for:

Business

b C o m m u t i n g (see i n s t r u c t i o n s )

W a s y o u r vehicle available f o r personal use during off-duty hours?

Oo you (or your spouse) have another vehicle available for personaluse?.

.

Do you have evidence to support yourdeduction?

ee

If ?Yes,?

48

is

the evidencew r i t t e n ?

Total other expenses.

-

.

2 .

2 .

. ee

.

.

e

.

.

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.

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.

.

.

.

.

.

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.

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oe

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.

.

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No

Yo

( N o

Yes

[ N o

.

Schedule C ( F o r m 1040)2 0 1 8

(This page has been intentionally left blank.)

Supplemental Documentation Materials

24

Publication 535

Contents

Business Expenses

Introduction

.............

1

What's New

.............

i

What's New

.............

2

Chapter 1. Deducting Business Expenses . . . . . . . . . . . . . .

2

Cat. No. 150652 Department of the Treasury Internal Revenue Service

Reminders . . . .

Chapter 2. Employees' Pay . . . . . . . . Z

This is where the intangible drilling deduction is documented and discussed.

Chapter 3. Rent Expense Chapter 4. Interest Chapter 5. Taxes

. . . . . . . . 10

. . . . . . . . . . . . 12 17

.............

Chapter 6. Insurance . . . . . . . . . . . 19 Chapter 7. Costs You Can Deduct or Capitalize . . . . . . . . . . . .

i

Chapter 8. Amortization Chapter 9. Depletion

23

. . . . . . . . . g_z

. . . . . . . . . . . 34

j

Chapter 10. Business Bad Debts . . . . 39 Chapter 11. Other Expenses

. . . . . . 42

Chapter 12. How To Get Tax Help Index

. . . 48

.....................

54

Introduction This publication discusses common business expenses and explains what is and is not deductible. The general rules for deducting business expenses are discussed in the opening chapter. The chapters that follow cover specific expenses and list other publications and forms you may need.

Note. Section references within this publication are to the Internal Revenue Code and regulation references are to the Income Tax Regulations under the Code.

Comments and suggestions. We welcome your comments about this publication and your suggestions for future editions.

You can send us comments from IRS.gov/ Form Comments. Or you can write to: Internal Revenue Service Tax Forms and Publications 1111 Constitution Ave. NW, IR-6526 Washington, DC 20224 Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax forms, instructions, and publications.

Internet: www.irs.gov

Ordering forms and publications. Visit IRS.gov/FormsPubs to download forms and publications. Otherwise, you can go to IRS. gov/ OrderForms to order current and prior-year

e

e

Depletion

if y o u d o not e l e c t to d e d u c t y o u r I D C s a s a

a

7.

with the m o n t h t h e y w e r e p a i d or i n c u r r e d .

C o s t s Y o u Can D e d u c t or Capitalize

«

If y o u c a p i t a l i z e a cost. y o u m a y b e able to r e c o v e r it o v e r a p e r i o d of y e a r s t h r o u g h p e r i o d i c d e d u c t i o n s for a m o r t i z a t i o n , depletion, o r d e p r e c i a t i o n . W h e n y o u c a p i t a l i z e a cost, y o u a d d it to the b a s i s of p r o p e r t y to w h i c h it relates.

A p a r t n e r s h i p , c o r p o r a t i o n , estate, o r t r u s t m a k e s the e l e c t i o n to d e d u c t or c a p i t a l i z e the Costs d i s c u s s e d in t h i s c h a p t e r e x c e p t f o r exploration costs for mineral deposits. Each (individual p a r t n e r , s h a r e h o l d e r , o r b e n e f i c i a r y e l e c t s w h e t h e r to d e d u c t or c a p i t a l i z e e x p l o r a t i o n costs.

Y o u m a y b e s u b j e c t to t h e a l t e r n a t i v e m i n i m u m t a x (AMT) i f y o u deduct research a n d e x p e n m e n t a l , i n t a n g i b l e drilling, e x p l o r a t i o n , d e v e l o p m e n t , circulation, a n d b u s i n e s s o r g a n i z a t i o n a l costs. F o r m o r e i n f o r m a t i o n o n the a l l e m a t i v e m i n i m u m tax, s e e t h e i n s t r u c t i o n s f o r o n e o f the f o l l o w i n g f o r m s . * F o r m 6251, A l t e m a t i v e M i n i m u m T a x ? individuals. © F o r m 4626, A i t e m a t i v e M i n i m u m T a x ?

Corporations.

intangible Drilling Costs T h e c o s t s of d e v e l o p i n g oil, g a s , or g e o t h e r m a l wells are ordinanly capital expenditures. Y o u can usually recover t h e m through depreciation or d e p l e t i o n . H o w e v e r , y o u c a n elect to d e d u c t i n t a n g i b l e drilling c o s t s ( I D C s ) a s a c u r r e n t b u s i n e s s e x p e n s e . T h e s e a r e certain drilling a n d d e v e l o p m e n t c o s t s f o r w e l i s in the U n i t e d S t a t e s

A m o u n t s p a i d to c o n t r a c t o r t h a t m u s t b e capitali z e d , later.

Y o u c a n a l s o e l e c t to d e d u c t t h e cost of d r i l l i n g e x p l o r a t o r y b o r e h o l e s to d e t e r m i n e the l o c a t i o n a n d d e l i n e a t i o n of o f f s h o r e h y d r o c a r b o n d e p o s i t s if the shatt is c a p a b l e of c o n d u c t i n g h y d r o c a r b o n s to the s u r f a c e o n completion. It d o e s not m a t t e r w h e t h e r t h e r e is a n y i n t e n t to produce hydrocarbons.

A m o u n t s p r o p e r l y a l l o c a b l e to t h e c o s t of d e p r e c i a b l e property, o r

Topics This chapter discusses: « Who can claim depletion * Mineral property e Timber

p r o c e e d s f r o m p r o d u c t i o n if t h e s e a m o u n t s a r e d e p l e t a b t e i n c o m e to the recipient.

H o w to m a k e t h e e l e c t i o n . Y o u e l e c t to d e d u c t

You generally deduct a cost as a current business expense by subtracting it from your income in either the year you incur it or the year you pay it

in w h i c h y o u h o l d a n o p e r a t i n g o r w o r k i n g i n t e r e s t . Y o u c a n d e d u c t o n l y c o s t s f o r drilling o r p r e p a r i n g a w e l l f o r t h e p r o d u c t i o n of oii, g a s , o r g e o t h e r m a l s t e a m or h o t w a t e r .

Y o u c a n e l e c t to d e d u c t o n l y t h e costs of i t e m s with n o s a l v a g e v a l u e . T h e s e i n c l u d e w a g e s , fuel, r e p a i r s , h a u l i n g , a n d s u p p l i e s r e l a t e d to drilling wells a n d p r e p a r i n g t h e m f o r p r o d u c t i o n . Y o u r c o s t f o r a n y drilling o r development work done by contractors under any form o f c o n t r a c t is a l s o a n I D C . H o w e v e r , s e e

cost depletion a n d p e r c e n t a g e depletion. For m i n e r a l p r o p e r t y , y o u g e n e r a l l y m u s t u s e the m e t h o d t h a t g i v e s y o u the l a r g e r d e d u c t i o n . F o r standing timber, you must use cost depletion.

¢ A m o u n t s p a i d o n l y out of p r o d u c t i o n o r

T h i s c h a p t e r d i s c u s s e s c o s t s y o u c a n elect to in d e d u c t or c a p i t a l i z e .

I D C s a sa c u r r e n t b u s i n e s s e x p e n s e b y t a k i n g the d e d u c t i o n o n y o u r i n c o m e t a x r e t u r n f o r the first t a x year y o u h a v e eligible costs. N o f o r m a t S t a t e m e n t is required. If y o u file S c h e d u l e C { F o r m 1040), e n t e r t h e s e c o s t s u n d e r ?Other expenses.?

F o r oil a n d g a s walls, y o u r e l e c t i o n is b i n d i n g f o r the y e a r it 1s m a d e a n d f o r all l a t e r y e a r s . F o r g e o t h e r m a l w e l l s , your e l e c t i o n can b e r e v o k e d by the f i l i n g o f a n a m e n d e d r e t u m o n w h i c h you d o not t a k e t h e d e d u c t i o n . Y o u c a n file the a m e n d e d return f o r the y e a r u p to t h e n o r m a l t i m e of e x p i r a t i o n f o r f i l i n g a c l a i m f o r credit o r r e f u n d , generally, w i t h i n 3 y e a r s a f t e r the d a t e y o u filed the original r e t u r n o r w i t h i n 2 y e a r s a f t e r the d a t e you p a i d the tax, w h i c h e v e r is later.

Who Can Claim Depletion?

If y o u h a v e a n e c o n o m i c i n t e r e s t i n m i n e r a l P r o p e r t y or s t a n d i n g t i m b e r , y o u c a n t a k e a d e d u c t i o n f o r d e p l e t i o n . M o r e than o n e p e r s o n c a n h a v e an e c o n o m i c interest in t h e s a m e m i n e r a ! d e p o s i t or t i m b e r .

Y o u h a v e a n e c o n o m i c i n t e r e s t if b o t h the following apply.

* You have acquired by investment any interest in mineral deposits or standing timber * You have a legai right to income from the extraction of the mineral or cutting of the timber to which you must look for a return of your capital investment.

Energy credit f o r costs of geothermal wells. if y o u c a p i t a l i z e t h e drilling a n d d e v e l o p m e n t costs o f geothermal wells that you place in s e r v i c e during the t a x y e a r , y o u m a y b e a b l e to c l a i m a b u s i n e s s e n e r g y credit. S e e t h e instructions for Form 3468 for m o r e information.

A contractual relationship that a l l o w s you an economic or monetary a d v a n t a g e from products of the m i n e r a l d e p o s i t o r s t a n d i n g t i m b e r is not, in itself, a n e c o n o m u c i n t e r e s t . A p r o d u c t i o n P a y m e n t c a r v e d o u t of, o r r e t a i n e d o n the s a l e of, m i n e r a l p r o p e r t y i s n o t a n e c o n o m i c interest. individuals, corporations, estates, a n d trusts who claim depletion d e d u c t i o n s m a y b e liable f o r a l t e m a t i v e m i n i m u m tax.

N o n p r o d u c t i v e w e l l . If y o u capitalize your IDCs, y o u h a v e a n o t h e r o p t i o n if the w e l l is n o n p r o d u c t i v e . Y o u can d e d u c t t h e I D C s o f the N o n p r o d u c t i v e w e l l a s an o r d i n a r y joss. Y o u m u s t i n d i c a t e a n d c l e a r l y state y o u r e l e c t i o n o n y o u r tax r e t u m f o r the y e a r the w a l l i s c o m p l e t e d .

O n c e m a d e , the e l e c t i o n f o r oi! a n d g a s w e l l s is b i n d i n g f o r all l a t e r y e a r s . Y o u can r e v o k e y o u r e l e c t i o n f o r a g e o t h e r m a l well b y f i l i n g a n a m e n d e d r e t u m t h a t d o e s not c l a i m the loss.

Mineral P r o p e r t y M i n e r a l p r o p e r t y i n c l u d e s oil a n d g a s w e l l s , mines, a n d other natural deposits {including geothermal deposits). For this purpose, t h e term ?property? m e a n s e a c h s e p a r a t e i n t e r e s t y o u o w n in e a c h m i n e r a l d e p o s i t in e a c h s e p a r a t e t r a c t o r p a r c e l of land. Y o u c a n t r e a t t w o or m o r e

Costs incurred outside t h e United States.

You cannot deduct as a current business e x p e n s e all the I D C s p a i d o r i n c u r r e d f o r a n oil, gas, or g e o t h e r m a l well l o c a t e d o u t s i d e the U n i t e d S t a t e s . H o w e v e r , y o u c a n e l e c t to i n c l u d e t h e c o s t s in t h e a d j u s t e d b a s i s of the w e l l to f i g u r e d e p l e t i o n o r d e p r e c i a t i o n . If y o u d o not m a k e this election, you can d e d u c t t h e costs o v e r t h e 1 0 - y e a r p e r i o d b e g i n n i n g with the t a x y e a r in w h i c h y o u p a i d o r i n c u r r e d them. T h e s e rules d o not a p p l y to a n o n p r o d u c t i v e w el l .

Separate interests as o n e property or as separate p r o p e r t i e s . S e e s e c t i o n 6 1 4 of the i n t e r n a l Revenue C o d e a n d t h e related regulations for t u l e s o n h o w to treat s e p a r a t e m i n e r a l interests.

es

9.

Depletion Introduction

:

_

t h e using up o f natural resources by

reserves.

T h e r e a r e t w o w a y s of f i g u r i n g d e p l e t i o n :

A m o u n t s pald to contractor that m u s t be c a p i t a l i z e d . A m o u n t s p a i d to a c o n t r a c t o r m u s t be c a p i t a l i z e d if t h e y a r e either:

Introduction

1s

m i n i n g , q u a r r y i n g , d n i l i n g , o r felling. T h e depletion deduction a l l o w s an o w n e r or operator t o a c c o u n t f o r t h e r e d u c t i o n of a p r o d u c t ' s

c u r r e n t b u s i n e s s e x p e n s e , you c a n e l e c t to d e d u c t t h e m over the 6 0 - m o n t h p e r i o d b e g i n n i n g

There are two ways of figuring depletion on mineral property. ¢ Cost depletion. ¢ Percentage depletion. ° G e n e r a l l y , y o u m u s t u s e t h e m e t h o d t h a tg i v e s y o u the l a r g e r d e d u c t i o n . H o w e v e r , u n l e s s y o u are an independent producer or royalty owner, you generally cannot use percentage depletion f o r o i l a n d g a s w e l l s . S e e Oil a n d G a s Wells, later.

Percentage Depletion To figura percentage depletion, you multiply a certain percentage, specitied for each mineral,

Intangible Drilling Costs & Deplétié®

26

by your g r o s s i n c o m e from the property during t h e tax year.

The r a t e s to b e u s e d a n d o t h e r c o n d i t i o n s

h o w t o f i g u r e the o r d i n a r y g a i n a l l o c a b i e to the property.

a n d qualifications for oil a n d gas wells are discussed later under I n d e p e n d e n t P r o d u c e r s

You cannot claim percentage depletion for an oil

« A n y r e n t s of r o y a l t i e s y o u p a i d o r i n c u r r e d f o r the p r o p e r t y . * T h e p a r t of a n y b o n u s y o u p a i d f o r a l e a s e

T h e well p r o d u c e s natural gas that is either s o l d u n d e r a f i x e d c o n t r a c t or p r o d u c e d f r o m geopressured brine.

natural gas, or their by-products. c. T o any person given authority u n d e r an a g r e e m e n t with y o u o r a r e l a t e d p e r s o n to o c c u p y a n y retail o u t l e t o w n e d , l e a s e d , o r controlled by you or a related person.

2. T h e c o m b i n e d g r o s s r e c e i p t s f r o m s a l e s ( n o t c o u n t i n g r e s a l e s ) o f oil, n a t u r a l g a s , o r t h e i r b y - p r o d u c t s b y a l l retail o u t l e t s t a k e n into a c c o u n t in (1) a r e m o r e than $ 5 million f o r t h e t a x year.

b y the j e s s o r .

U s e t h e f o l l o w i n g f r a c t i o n to f i g u r e t h e p a r t o f t h e b o n u s you must subtract.

Independent Producers and

5

Royalty Owners

Bonus x Payments

For oil a n d g a s wells a n d g e o t h e r m a l

If y o u a r e a n i n d e p e n d e n t p r o d u c e r o r r o y a l t y owner, you figure percentage depletion using a r a t e of 1 5 % of the g r o s s i n c o m e f r o m t h e p r o p e r t y b a s e d on your a v e r a g e daily production o f d o m e s t i c c r u d e oil or d o m e s t i c n a t u r a l g a s u p t o y o u r d e p l e t a b l e oi! o r n a t u r a l g a s q u a n t i t y .

H o w e v e r , c e r t a i n refiners, a s e x p l a i n e d next, a n d c e r t a i n r e t a i l e r s a n d t r a n s f e r e e s of p r o v e n o i l a n d g a s properties, a s e x p l a i n e d later, cannot p r o c l a i m p e r c e n t a g e depletion. F o r i n f o r m a t i o n o n f i g u r i n g the d e d u c t i o n , s e e F i g u r i n g { P e r c e n t a g e depletion, later.

4

d e p o s i t s , g r o s s i n c o m e f r o m t h e p r o p e r t y is d e f i n e d l a t e r u n d e r O i ! a n d G a s Welis. F o r p r o p e r t y o t h e r than a g e o t h e r m a l d e p o s i t o r a n oil a n d g a s well, g r o s s i n c o m e f r o m t h e p r o p e r t y is defined later u n d e r Mines a n d G e o t h e r m a l Deposits.

Taxable I n c o m e limit. The percentage depletion deduction generally cannot be more than 5 0 % ( 1 0 0 % f o r oil a n d g a s p r o p e r t y ) of y o u r t a x a b l e i n c o m e f r o m the p r o p e r t y f i g u r e d w i t h o u t t h e depletion deduction a n d the domestic production activities d e d u c t i o n .

Taxable income from the property m e a n s g r o s s i n c o m e f r o m t h e p r o p e r t y m i n u s all allowable deductions (excluding any deduction for depletion or qualified d o m e s t i c production activities) attributable t o mining processes, including mining transportation. These deductible items include the following.

Operating expenses.

e C e r t a i n selling e x p e n s e s .

« Administrative a n d financial overhead. « Depreciation. i n t a n g i b l e d r i l l i n g a n d d e v e l o p m e n t costs.

Exploration and development expenditures.

T h e f o l l o w i n g rules a p p l y w h e n f i g u r i n g y o u r t a x a b l e i n c o m e f r o m t h e p r o p e r t y f o r p u r p o s e s of t h e t a x a b l e i n c o m e limit. e D o n o t d e d u c t a n y net o p e r a t i n g l o s s d e d u c t i o n f r o m t h e g r o s s i n c o m e f r o m the

«

©

For information on t h e depletion deduction f o r w e l l s that p r o d u c e n a t u r a l g a s t h a t is e i t h e r s o l d u n d e ra f i x e d c o n t r a c t o r p r o d u c e d from g e o p r e s s u r e d brine, see N a t u r a l G a s Wells, later.

A b o n u s p a y m e n t includes a m o u n t s you paid as a lessee t o satisfy a p r o d u c t i o n p a y m e n t retained

©

Y o u a r e e i t h e r a n i n d e p e n d e n t p r o d u c e r or & royalty owner.

owner, s e e I n d e p e n d e n t Producers a n d Royalty O w n e r s , next.

t a x year.

«

«

\f y o u a r e a n i n d e p e n d e n t p r o d u c e r or r o y a l t y

o n the p r o p e r t y a l l o c a b l e to the p r o d u c t s o l d (or t h a t o t h e r w i s e g i v e s rise to g r o s s i n c o m e ) f o r t h e

©

the f o l l o w i n g s i t u a t i o n s . a. T h r o u g h a retail o u t l e t o p e r a t e d by y o u o r a related person. b. T o a n y p e r s o n w h o is r e q u i r e d u n d e r a n a g r e e m e n t with y o u o r a r e l a t e d p e r s o n t o use a trademark, trade n a m e , or service m a r k or n a m e o w n e d b y y o u o r a r e l a t e d p e r s o n in m a r k e t i n g o r d i s t r i b u t i n g oil,

o r g a s w e l l u n l e s s at l e a s t o n e of t h e f o l l o w i n g applies.

G r o s s I n c o m e . W h e n figuring your p e r c e n t a g e depletion, subtract from your gross i n c o m e from the p r o p e r t y the f o l l o w i n g a m o u n t s .

property

e m e t o n if b o t h t h e f o l l o w i n g a p p l y . . Y o u sell o i l or n a t u r a l g a s or t h e i r b y - p r o d u c t s d i r e c t l y o r t h r o u g h a r e l a t e d p e r s o n in a n y o f

Oil a n d Gas Wells

a n d Royalty O w n e r s a n d under Natural G a s W e l l s . R a t e s a n d o t h e r rules f o r p e r c e n t a g e d e p l e t i o n of o t h e r s p e c i f i c m i n e r a l s a r e f o u n d l a t e r in M i n e s a n d G e o t h e r m a l D e p o s i t s .

No. of u n i t s s o i d in t h e t a x y e a r Recoverable units f r o m t h e

Retailers w h o cannot claim percentage depletion. You cannot claim percentage

property.

Corporations do n o t deduct charitable c o n t r i b u t i o n s f r o m the g r o s s i n c o m e f r o m

Refiners w h o cannot claim percentage d e p l e t i o n . You cannot claim percentage d e p l e t i o n if y o u or a r e l a t e d p e r s o n r e f i n e c r u d e o i l a n d y o u a n d the r e l a t e d p e r s o n r e f i n e d m o r e t h a n 7 5 , 0 0 0 b a r r e l s o n a n y d a y d u r i n g the t a x y e a r b a s e d o n a v e r a g e ( r a t h e r than actual) d a i l y r e f i n e r y runs f o r the tax y e a r . T h e a v e r a g e daily r e f i n e r y run is c o m p u t e d by dividing total r e f i n e r y runs f o r the t a x y e a r by t h e total n u m b e r of d a y s in the t a x year.

F o r t h e p u r p o s e o f d e t e r m i n i n g if t h i s r u l e applies, d o not c o u n t the f o l l o w i n g . ¢ B u l k sales ( s a l e s in v e r y large q u a n t i t i e s ) of oil

o r n a t u r a l g a s to c o m m e r c i a l o r i n d u s t r i a l users. ¢ B u l k sales o f a v i a t i o n f u e l s to t h e D e p a r t m e n t ot D e f e n s e . e S a l e s of oil o r n a t u r a l g a s or t h e i r b y - p r o d u c t s

o u t s i d e t h e U n i t e d S t a t e s if n o n e o f y o u r d o m e s t i c production or that o f a related p e r s o n is e x p o r t e d d u r i n g the t a x y e a r o r the p ri o r t a x year.

R e l a t e d p e r s o n . T o d e t e r m i n e if y o u a n d another person are related persons, see R e l a t e d person under Refiners who cannot claim p e r c e n t a g e d e p l e t i o n , earlier.

Sales t h r o u g h a r e l a t e d p e r s o n . You are c o n s i d e r e d to b e selling t h r o u g h a r e l a t e d p e r s o n if a n y s a l e b y t h e r e l a t e d p e r s o n p r o d u c e s g r o s s i n c o m e f r o m w h i c h y o u m a y b e n e f i t b e c a u s e of your direct or indirect o w n e r s h i p i n t e r e s t i n t h e person.

R e l a t e d p e r s o n , You and another person a r e r e l a t e d p e r s o n s if e i t h e r of y o u h o l d s a s i g n i f i c a n t o w n e r s h i p interest in the o t h e r p e r s o n o r if t h i r d p e r s o n h o l d s a significant o w n e r s h i p Interest in b o t h of y o u .

F o r e x a m p l e , a c o r p o r a t i o n , p a r t n e r s h i p , estate, o r t r u s t a n d a n y o n e w h o h o l d sa s i g n i f i c a n t o w n e r s h i p i n t e r e s t in it a r e r e l a t e d p e r s o n s . A p a r t n e r s h i p a n d a t r u s t a r e related p e r s o n s if o n e p e r s o n h o l d s a s i g n i f i c a n t o w n e r s h i p i n t e r e s t in e a c h of them.

F o r p u r p o s e s of the r e l a t e d p e r s o n rules, s i g n i f i c a n t o w n e r s h i p interest m e a n s direct o r i n d i r e c t o w n e r s h i p of 5 % o r m o r e in a n y o n e of the following. * T h e v a l u e of t h e o u t s t a n d i n g s t o c k of a corporation. ¢ T h e i n t e r e s t in the p r o f i t s or c a p i t a l of a

the p r o p e r t y .

If, d u r i n g the y e a r , y o u d i s p o s e of a n i t e m of section 1 2 4 5 p r o p e r t y that was used in c o n n e c t i o n with m i n e r a l p r o p e r t y , r e d u c e

partnership. « T h e b e n e f i c i a l i n t e r e s t s i n an e s t a t e or t r u s t .

any a l l o w a b l e d e d u c t i o n for mining e x p e n s e s by the p a r t o f a n y g a i n y o u m u s t r e p o r t a s o r d i n a r y i n c o m e t h a tis a l l o c a b l e to the m i n e r a l property. S e e s e c t i o n 1 . 6 1 3 5 ( b ) ( 1 ) o f the r e g u i a t i o n s f o r i n f o r m a t i o n o n

A n y interest owned by or for a corporation, p a r t n e r s h i p , trust, o r e s t a t e is c o n s i d e r e d to b e o w n e d d i r e c t l y both b y i t s e l f a n d p r o p o r t i o n a t e l y b y its s h a r e h o l d e r s , p a r t n e r s , o r b e n e t i c i a r i e s .

Jntangible Drilling Costs & Depletio#

US TAX CODE, Section 469.c.3 Code has not For practical purposes, the entire section 469.c.3 of the US Tax been included, only relevant highlights.

469. Passive activity losses and credits limited (3) Working interests in oil and gas property (A) In general

The term "passive activity" shall not include any working interest in any oil or gas property which the taxpayer holds directly or through an entity which does not limit the liability of the taxpayer with respect to such interest.

(B) Income in subsequent years

If any taxpayer has any loss for any taxable year from a working interest in any oil or gas property which is treated as a loss which is not from a passive activity, then any net income from such property (or any property the basis of which is determined in whole or in part by reference to the basis of such property) for any succeeding taxable year shall be treated as income of the taxpayer which is not from a passive activity. If the preceding sentence applies to the net income from any property for any taxable year, any credits allowable under subpart B (other than section 27 @l) or D of part IV of subchapter A for such taxable year which are attributable to such property shall be treated as credits not from a passive activity to the extent the amount of such credits does not exceed the regular tax liability of the taxpayer for the taxable year which is allocable to such net income.

28

US Tax Code, Section 263 For practical purposes, the entire section 263 of the US Tax Code has not been included, only relevant highlights.

263. Capital expenditures (c) Intangible drilling and development costs in the case of oil and gas wells and geothermal wells

Notwithstanding subsection (a), and except as provided in subsection (i), regulations shall be prescribed by the Secretary under this subtitle corresponding to the regulations which granted the option to deduct as expenses intangible drilling and development costs in the case of oil and gas wells and which were recognized and approved by the Congress in House Concurrent Resolution 50, Seventy-ninth Congress. Such regulations shall also grant the option to deduct as expenses intangible drilling and development costs in the case of wells drilled for any geothermal deposit (as defined in section 613 (e)(2)) to the same extent and in the same manner as such expenses are deductible in the case of oil and gas wells. This subsection shall not apply with respect to any costs to which any deduction is allowed under section 59 (e) or 291.

(6) Application of this subsection with subsection (g) (i) Special rules for intangible drilling and development costs incurred outside the United States

In the case of intangible drilling and development costs paid or incurred with respect to an oil, gas, or geothermal well located outside the United States(1) subsection (c) shall not apply, and (2) such costs s h a l l -

(A) at the election of the taxpayer, be included in adjusted basis for purposes of computing the amount of any deduction allowable under section 611 (determined without regard to section 613), or

(B) if subparagraph (A) does not apply, be allowed as a deduction ratably over the 10-taxable year period beginning with the taxable year in which such costs were paid or incurred.

This subsection shall not apply to costs paid or incurred with respect to a nonproductive well.