Applicable Tax Codes

The IDC deduction has been a feature of the US tax code since 1913, designed to incentivize investment in the risky venture of oil and gas exploration. IDC can be deducted in the year incurred, while tangible drilling costs are amortized over a seven-year period. Owners of working interests in wells can typically deduct 60-80% of the total well cost as IDC, effectively granting a $24 tax reduction for every $100 invested, thereby reducing the net investment to $75.

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Additionally, the IDC deduction can be used to offset other income immediately, providing further tax benefits. Under IRS Code Section 461, IDCs paid before December 31st of a tax year can still be deducted in that year, provided drilling of the well commences before the close of the 90th day after the taxable year's end.

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It's worth noting that while integrated oil companies must reduce the allowable IDC by 30%, independent producers can expense the full IDC amount. Furthermore, the election to deduct intangible drilling costs is binding for future years.

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For wells recognized as secondary recovery, such as water and gas injection wells, IDCs are incurred in preparation for production and are therefore subject to the same deduction rules. However, operators may not deduct IDCs for wells located outside the US, with such costs subject to a 10-year straight-line amortization schedule.

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Certain IDCs, such as those related to drilling water wells for hydraulic fracturing or secondary recovery, may qualify for deduction, while others, such as drilling water wells for water disposal, are typically capitalized as lease and well equipment expenses. It's important to note that, for properties placed in service after 1986, expensed costs are subject to recapture as ordinary income upon disposal, including exploration and intangible drilling and development costs.

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In summary, the IDC deduction remains a valuable tax incentive for investors in the oil and gas industry, though certain restrictions and recapture provisions apply, in accordance with the US tax code.

 

Summarized

- IDC deduction allows immediate tax reduction for oil and gas investments.
- Owners of working interests can typically deduct 60-80% of total well cost as IDC.
- $24 deduction for every $100 invested, reducing net investment to $75.
- IDC deductible in the year incurred; tangible drilling costs amortized over 7 years.
- Independent producers can expense full IDC amount; integrated oil companies face 30% reduction.
- Election to deduct intangible drilling costs is binding for future years.
- IDCs for secondary recovery wells subject to same deduction rules.
- IDCs for wells outside US not deductible; subject to 10-year amortization.
- Certain IDCs, like drilling water wells for hydraulic fracturing, may qualify for deduction.
- Recapture provisions apply for expensed costs upon property disposal.