[jeff]

Long story short – I have a church friend who invested in an oil project. They’re just a passive investor.

This isn’t my area of expertise at all and I aside from “ask your CPA”, I was trying to point them in the right direction as far as deductibility of drilling costs – Intangible and Tangible.

They invested $7k for the drilling costs and $13k to complete the well.

Is the $7k a complete writeoff in the year of payment?

Thanks for any pointers.

[stoleway]

Hey Jeff, im not in oil and gas but my Dad-in-law is and his accountants always writeoff the drilling cost in the year it was incurred ( the intangible part since it doesnt result in any physical asset).

The tangible aspect such as the amount spent in constructing a well from beginning to completeion is actually ammortised depending on its useful life.

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[Anonymous]

1. Is the well producing or was it a dry hole?

2. I assume he isn't the sole owner if his interest is passive, so does he own stock in a corporation that drilled this well, or was it another business entity?

3. Were there proven reserves on the property surrounding this well?

[Garion]

It's been a while since my Oil & Gas days but Kricket is asking the right questions. If I remember correctly you should be able expense/write-off a dry hole under a ‘successful efforts' method for an E&P. Otherwise you should capitalize it all but I forget the name of that method and then… Drill Baby Drill!!!

I am sure if you check out one of the O&G 10K's it will have disclosure in there highlighting the GAAP accounting policy.

Not sure about tax treatment though. I left that to the tax dept.

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[jeff]

1. Is the well producing or was it a dry hole?

– Not producing – they are going to use it as a disposal well

2. I assume he isn't the sole owner if his interest is passive, so does he own stock in a corporation that drilled this well, or was it another business entity?

– I believe he formed an LLC and has a fractional interest in the project (there were 15-20 investors)

3. Were there proven reserves on the property surrounding this well?

– No – this was a total wildcat. The hole had oil, but a lot of water too and it was cost-prohibitive to truck the water off, I guess. They're going to drill another hole and then make this one a disposal last I heard.

[thechapman]

I believe that the $7k drilling cost would be considered an intangible drilling cost because it's not something that has some sort of salvage value. Since you can't capitalize that, you are allowed to deduct it as a business expense in the year you incur the cost. This may be a little oversimplified, but I believe that is the quick and dirty. For the record I'm not a CPA, but I did just have to take an oil and gas accounting class recently.

This might help also https://www.irs.gov/publications/p535/ch07.html#en_US_2013_publink1000208883

Passed - 2014

[Anonymous]

He has a Service well at this point, even though it doesn't meet the definition of a service well. Those are drilled specificially to support production. His well is an Exploratory well that could be classified as a “dry hole” and expensed. Since they know there is oil there, he may not want to do that at this point. If the second well comes in, and comes in big, then he is going to have some serious taxable income in the future. He may need the expense later on to offset those earnings. A Service well can be capitalized to a Production well and be depleted using Units of Production. Since this is an LLC the election is left up to each member, so one person may capitalize the whole thing, and another may expense the whole thing. He might consider expensing the $7,000 this year and capitalizing the $13,000 to the second well if it produces. That way he covers his bases and has something to offset the potential future taxable income. But this is a guess on my part, because I don't have any other information. I am not offering any tax advice here, just a personal opinion.

[jeff]

Thanks everyone. I think I'll recommend he talk to his CPA 🙂

[rnguyen7]

Hey Jeff,

I currently work in an E&P company and it depends on your question. If it is for tax purposes, you are able to write off the intangible cost. Drilling and Completion can also be considered intangible cost so it really depends on who keeps the companies books. There are some completions that could be considered tangible versus intangible. For an example, if there is something like frac fluids, putting the well on pump, flowback phases etc. This could be costs to complete the well but is considered intangible. Then there is also tangible completions like casing, tubing etc.

[Author]

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