J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

9.14 Intangible Drilling Costs

Intangible drilling and development costs (IDCs) refer to drilling and development costs of items with no salvage value, including wages, fuel, repairs, hauling, and supplies incident to and necessary for the preparation and drilling of wells for the production of oil or gas, and geothermal wells. For wells you are developing in the United States, you can elect to deduct the costs currently as business expenses or treat them as capital expenses subject to depreciation or depletion.

Electing current business deduction.

The election to deduct IDCs as a current business expense must be made on your income tax return for the first tax year in which you pay or incur the costs. As a sole proprietor, you deduct the IDCs as “other expenses” on Schedule C (Form 1040).

Prepayments. Tax-shelter investors may deduct prepayments of drilling expenses only if the well is “spudded” within 90 days after the close of the taxable year in which the prepayment is made. The prepayment must also have a business purpose, not be a deposit, and not materially distort income. The investor’s deduction is limited to his or her cash investment in the tax shelter. For purposes of this limitation, an investor’s cash investment includes loans that are not secured by his or her shelter interest or the shelter’s assets and loans that are not arranged by the organizer or promoter. If the above tests are not met, a deduction may be claimed only as actual drilling services are provided. ...