In many oil and gas programs, the investor will be able to take first year income tax deductions for the intangible drilling and development costs associated with drilling the wells.
Previously, income programs were generally not considered to be "tax shelters" because deductions for percentage depletion and intangible drilling and development costs were generally not available.
The two deductions that are peculiar to oil and gas programs (and certain other extractive industries) and that provide the major incentives for investing in an oil or gas limited partnership are the deductions for intangible drilling and development costs (see Q 7841 to Q 7844) and depletion (see Q 7845 to Q 7854).
Intangible drilling and development costs (more commonly referred to as "intangible drilling costs" or "IDCs") are expenditures made by an operator in the development of an oil or natural gas property for wages, fuel, repairs, hauling, supplies, etc.
If drilling and development work is done by a contractor under an agreement with the operator, intangible drilling and development costs do not include those amounts that are payable to the contractor out of production or proceeds from production if such amounts are depletable income in the hands of the contractor, or amounts that are properly allocable to the cost of depreciable property.
Numerous rulings and cases have considered the eligibility of specific expenditures to be treated as intangible drilling and development costs and the special problems encountered in the case of offshore wells.
How are intangible drilling and development costs treated for purposes of the federal income tax?
Intangible drilling and development costs (IDCs) are capital in nature; however, the IRC and regulations provide a choice of alternatives for treatment of such costs.
As to how individual limited partners treat their allocated shares of intangible drilling and development costs after the partnership has made its election to capitalize or expense, see Q 7843 and Q 7844.
Answer--An investor with an interest in oil or gas property has two choices with respect to intangible drilling and development costs.
Each limited partner can recover his share of capital expenditures on his personal income tax return through depletion or depreciation if the limited partnership elects to capitalize intangible drilling and development costs.