Oil & Gas Intangible Drilling Cost Programs

Classification B, legitimate, commonly abused. Real tax law with a real benefit. Promoters break it.

Sold as: "IDC", "60 to 80 percent first-year write-off", "the last major deduction standing", "working interest program", "turnkey drilling"

The nonpassive treatment is real, but it costs you unlimited liability. If the promoter is selling you LLC units, you cannot have both, and they know it.

The pitch

Intangible drilling costs run 60 to 80 percent of a well and come off in the first year, and a working interest is not passive under Sec. 469(c)(3), so the deduction lands against your active income. The last major deduction standing.

What it costs you if it is wrong

Hold through an entity that limits your liability and Sec. 469(c)(3) does not apply, so the loss is passive and waits for passive income or a disposition. Prepaid IDC where drilling has not begun is deferred under Sec. 461(i)(2), and nonrecourse promoter notes are cut back by Sec. 465. There is no listed-transaction designation here, so the exposure is the deduction and the interest rather than a disclosure penalty.

Red flags

You are buying LLC or LP units while being pitched the working interest exception
The pitch is to prepay before year end and drill later
The turnkey contract allocates almost everything to intangible costs
The promoter note is nonrecourse
The well economics only work with the deduction counted
Nobody mentioned that nonpassive treatment requires unlimited liability

Questions to ask the person selling this

1Am I buying a direct working interest, or units in an entity that limits my liability?
2If it limits my liability, how does Sec. 469(c)(3) still apply?
3When do the wells actually get drilled?
4What is the split between intangible and tangible costs, and what supports it?
5Is any of the promoter financing nonrecourse?
6What is the expected return before the deduction is counted?

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