Understanding Intangible Drilling Costs For Oil and Gas Properties
Intangible Drilling costs, also known as IDC can be an area of confusion for oil industry professionals as well as oil and gas investors. For accounting purposes, the IRS has set certain guidelines pertaining to what are considered intangible drilling costs and how they are treated for tax purposes. The purpose of this article is to provide some insight on these IDC as interpreted from the IRS Publication on the Oil and Gas industry – Market Segment Specialization Program. Although these publications can change from time to time, the guidelines discussed are from what appears to be the most current version as of February 2013. The full link to the publication can be found at this here or the full PDF version.
Intangible Drilling Costs (IDC)
Many costs in developing oil and gas properties are classified into twi different groups. Intangible Drilling Costs & Tangible Drilling Costs. Intangible Drilling Costs are considered to be expenses for drilling or developing oil and gas wells which have no salvage value but are necessary for the development, preparation and drilling of a crude oil or natural gas well.
Examples of Intangible Drilling Costs
According to the IRS Publication, the following items are considered to be intangible drilling costs:
- Administrative costs associated with an oil well or gas well drilling contract.
- Lease or Land Survey including 2D seismic or 3D seismic which help to locate a well site on a property.
- The cost of drilling an oil or gas well.
- Various dirt work performed to prepare the drill site such as grading and digging mud pits.
- The costs of building roads or canals to the actual drill site.
- Surface damages paid to the land owner.
- Payments made for damage to crops.
- The cost of setting the drilling rig on the drilling site.
- Rig moving and drilling rig transportation costs.
- Technical services paid to others engaged in the drilling of the oil or gas well such as the geologist or engineer.
- Drilling fluids and other supplies consumed during the well drill such as drilling mud.
- Transportation costs for drilling pipe and casing.
- The costs to cement the casing (Not the actual casing itself though).
- Rental equipment used in drilling the well such as tanks and special equipment.
- The perforation of the well casing.
- The cost of well logging (does not include the cost of velocity surveying).
- The costs to remove the rig from the location.
- Dirt work in conjunction with cleaning up the drill site.
- Other completion costs such as fracking and acidizing the formation.
- Well Swabbing in conjunction with completing the well.
- The costs to obtain an operating agreement for the drilling operations.
- If the well is dry, the costs to plug and abandon the well.
- Drill stem tests.
Tax Treatment of Intangible Drilling Costs
According to the IRS, a Working Interest Owner can elect to currently deduct the IDC in the or to capitalize the IDC costs. It it is important to note that if the election is not made, the costs will be considered capitalized and deducted over a number of years. There is not an option to change the election in the future, even through amended tax returns. In order to fully understand the tax treatment, please consult your tax professional or contact the IRS.
Tangible Drilling Costs
In addition to intangible drilling costs, other costs associated with the lease and well equipment are considered to be tangible drilling costs. For an overview on what items are considered tangible drilling costs such as lease and well equipment, please refer to Tangible Drilling Costs.