Drilling and Exploration Costs
Intangible Drilling Costs
The costs of developing oil, gas, or geothermal wells include wages, fuel, repairs, hauling, and supplies incident to and necessary for the preparation of the wells. A taxpayer who is developing these wells in the United States has the choice of treating the costs as capital expenditures and recovering them through depreciation or depletion or deducting the costs as current business expenses.
The only costs that qualify for a current deduction are those without a salvage value. In addition, a taxpayer can choose to deduct the cost of drilling exploratory bore holes to determine the location and delineation of offshore hydrocarbon deposits even if the taxpayer has no intention of producing hydrocarbons. However, certain amounts paid to a contractor are not eligible for a current deduction and must be capitalized.
A taxpayer who chooses to capitalize expenditures for intangible drilling costs must deduct them through amortization and depreciation over a 60-month period beginning with the month in which the expenses were paid or incurred.
Once the taxpayer who is developing gas and oil wells has chosen between taking a current deduction for intangible drilling costs or capitalizing them, the choice is binding for the year made and all the years to follow. However, he can revoke the election for geothermal wells.
When a taxpayer chooses to capitalize the drilling and development costs of a geothermal well that was placed in service during the tax year, he may be entitled to take a business energy credit on those expenditures.
If a well turns out to be nonproductive and the taxpayer has chosen to capitalize the intangible drilling costs connected with that well, he is entitled to deduct the drilling costs as an ordinary loss in the year in which the well was completed.
If the costs of determining the existence, location, extent, or quality of any mineral deposit lead to the development of a mine, they are usually treated as capital expenditures and recovered through depletion as the mineral is removed from the ground. However, the taxpayer can choose to deduct exploration costs in the United States paid or incurred before the development stage began. This rule does not apply to oil, gas, or geothermal wells.
When the mine begins producing, the taxpayer must recapture any exploration costs he chose to deduct. In addition, the taxpayer must recapture deducted exploration costs if he receives a bonus or royalty from mine property before it reaches the producing stage.
Copyright 2012 LexisNexis, a division of Reed Elsevier Inc.