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What is IDC?

The regulations define intangibles as any cost incurred than ii, itself has no salvage value and is incident and necessary for the drilling of wells and the.
preparation of wells for the production of oil and gas. This definition includes the cost of installation of tangible equipment placed in the well itself although the equipment is to be capitalized and depreciated. Intangible Drilling Costs include:
o Costs of agreements and negotiations in obtaining operator of the well.

o Costs incurred for agreements and negotiations with drilling contractors as
to bids for drilling.

o Survey and seismic work as to location of well site.

o Costs of road to location to be used during drilling.

o Costs of dirt work on location, cellar, pits, and drilling pack.

o Costs of transporting rig to location, and rig-up costs.

o Costs incurred for water, fuel and other items necessary for drilling the well.

o Costs of setting deadmen (anchors in the ground used to stabilize drilling rig).

o Drilling costs calculated on footage or day-rate basis. o Costs of technical services rendered during the drilling activities by engineers, geologists, fluid technicians, etc.

o Costs of logging and drill-stem test services.

o Costs of swabbing, fracturing, and acidizing.

o Costs of rental equipment for oil storage during testing.

o Costs of removing rig from location, trucking dozers, and labor

o Dirt work and clean-up of drill site.

o Cementing and installation of surface casing.

o Cementing of main casing.

o Transportation of casing and tubing from supply point.

o Perforation of casing, including electrical logging.

o Salt water, fresh water, and gas injection wells drilled soley for
pressurization or flooding of producing zone.

Expressly excluded from classification as intangibles are expenses, including installation charges, incurred for equipment, facilities, or structures that are not incident to the drilling of the well, such as structures for storing and treating oil or gas. (Section 1612-4 of the Code.) These costs are installation costs and are capitalized as part of those structures and recovered through tangible equipment depreciation.

Election to Expense or Capitalize

Any taxpayer (investor) who owns the operating rights in an oil or gas property and incurs intangible costs must elect to expense or to capitalize these costs. (Rev. Rul. 67-34, 1967-1 CB 72.) Although the Tax Reform Act of 1986 provides uniform rules for the capitalization of costs incurred regarding property used in production, intangible drilling costs are excluded from the capitalization rules (IRC, Section 263A). The election must be made by the tax payer (investor) for his first tax year in which intangibles are incurred. Once made, the election is binding on the taxpayer (investor) for all later years (IRC 1612-4). Each partner in a tax partnership is required to make their own election.
If the taxpayer elects to capitalize the intangible costs, an allocation must be made and the costs must be recovered (1) through depletion to the extent the costs are not represented by physical property or (2) through depreciation to the extent the costs are represented by physical property.
In making the election to expense intangibles, investors must consider that intangibles on productive wells incurred after December 31, 1975 (for noncorporate tax payers may be subject to the Alternative Minimum Tax. In addition, investors must be aware of the impact of potential recapture of

intangibles, if they sell or otherwise make a disposition of their interest in the future.
If the investor wants to expense intangibles, an express statement should be included with their return that the investor elects to deduct intangibles in accordance with the option granted by Regulation Section 1.612-4 (a).

Tax Treatment:

Election to Expense

Under the general rules, if an investor has properly elected to deduct ( expense) intangible drilling costs, the time for the deduction is the tax year in which the costs are incurred, by an "accrual-basis" tax payer, or in which such costs are paid, by a "cash-basis" tax payer. In Revenue Ruling 71-252, the IRS ruled that IDC paid under a contract (i.e. Turnkey Drilling Contracts) by a cash-basis taxpayer who had elected in a prior year to treat such costs as expenses, are deductible in the year paid even though the work is performed in the following year.

For tax years beginning after December 31, 1986 under the Tax Reform Act of 1986, economic performance must have occurred before prepayments can be deducted. For tax years beginning after December 31, 1986, economic performance is deemed to have occurred, if the drilling of the oil or gas well begins within 90 days of the close of the tax shelter's tax year. (IRC, Section 461 (i)(2) as amended by Section 801(b». For our investors, the well must be spudded by the 90th day of the year.

Election to Capitalize

If an investor elects to capitalize IDC, the regulations require that expenses not represented by physical property, such as clearing ground, draining, road making, surveying, geological work, excavating, grading, and the drilling, shooting, and cleaning of wells, be capitalized and recovered through cost depletion. Expenses represented by physical properties, including wages, fuel, repairs, hauling, supplies, and so on, used in the installation of casing and equipment when intangibles are capitalized, are to be recovered through depreciation.

However, a taxpayer may elect to annually capitalize these costs and deduct them over a 60 month period, beginning in the first month in which the expenditures were paid or incurred.

Capitalization of Intangible Drilling Costs is rarely more beneficial to an investor than electing to expense such costs, because statutory depletion does not require any basis in the property while cost depletion does.