7866 / What are “intangible drilling and development costs”?

Intangible drilling and development costs (more commonly referred to as “intangible drilling costs” or “IDCs”) are expenditures made by an operator in the development of an oil or natural gas property for wages, fuel, repairs, hauling, supplies, etc. Thus, intangible drilling costs generally include all amounts paid for labor, fuel, repairs, hauling, and supplies that are incurred in drilling, shooting, and cleaning wells; in clearing ground, draining, road making, surveying, and geological work necessary to prepare a site for drilling; and in constructing derricks, tanks, pipelines, and other physical structures necessary for drilling and the production of oil or natural gas.

On the other hand, intangible drilling costs do not include expenditures made to acquire tangible property ordinarily considered to have a salvage value. Thus, the costs of the actual materials in structures constructed in the wells or on the property and the cost of drilling tools, pipes, casings, tubings, tanks, engines, boilers, machines, etc. are not intangible drilling costs. However, wages, fuel, repairs, hauling, supplies, etc. are not considered to have salvage value even though they are incurred in connection with the installation of physical structures that themselves have salvage values.¹

Expenditures for wages, fuel, repairs, hauling, supplies, etc. incurred in connection with equipment, facilities, or structures that are not incident to or necessary for the drilling of wells (including expenditures for storing and drilling) are not intangible drilling costs. (These items must be capitalized and depreciated.)² Expenditures for drilling wells solely to obtain geological information and not for the production of oil or natural gas are not intangible drilling costs.³

Expenditures for labor, fuel, repairs, hauling, supplies, etc. incurred in connection with the actual operation of wells and other facilities on the property for the production of oil or natural gas are not intangible drilling costs, but must be treated as expenses.⁴

Expenditures for labor, fuel, repairs, hauling, supplies, etc. incurred in connection with the drilling of an injection well, or the conversion of a producing or nonproducing well to an injection well, are treated as intangible drilling costs.⁵

If drilling and development work is done by a contractor under an agreement with the operator, intangible drilling and development costs do not include those amounts that are payable to the contractor out of production or proceeds from production if such amounts are depletable income in the hands of the contractor, or amounts that are properly allocable to the cost of depreciable property. Otherwise, any type of contract (including a turnkey contract) between the operator and contractor may be used without jeopardizing the classification of expenditures as intangible drilling costs.⁶

Numerous rulings and cases have considered the eligibility of specific expenditures to be treated as intangible drilling and development costs and the special problems encountered in the case of offshore wells.⁷