(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.
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.
If a limited partnership (i.e., the operator) has elected to capitalize intangible drilling and development costs, the regulations provide an additional option with respect to intangible drilling and development costs incurred in drilling a nonproductive well.
Answer--An investor with an interest in oil or gas property has two choices with respect to intangible drilling and development costs
. He can (1) capitalize the intangible drilling costs, or (2) deduct them currently in the taxable year the expense is paid or incurred.
However, sale of stock in an S corporation that has deducted intangible drilling and development costs
(IDC), mining development and exploration expenditures, and depletion may result in ordinary income treatment.