7867 / How are intangible drilling and development costs treated for purposes of federal income tax?
Intangible drilling and development costs (IDCs) are capital in nature; however, the IRC and regulations provide alternatives for treatment of such costs. The individual or entity that holds the working or operating interest in the oil or gas property (i.e., the operator) may elect to (1) capitalize the IDCs or (2) deduct them as expenses for the taxable year in which they are paid or incurred.1 (With respect to oil or gas property located outside the United States, intangible drilling and development costs paid or incurred after 1986 must be (1) capitalized, or (2) deducted ratably over 10 years. This, however, does not apply to a nonproductive well.)2
If intangible drilling costs are capitalized, they may be recovered through depreciation or depletion (see Q 7877, Q 716).
In the case of certain enhanced oil recovery projects (generally referred to as tertiary recovery projects) begun or expanded after 1990, the operator may, instead of expensing or capitalizing IDCs, claim a tax credit generally equal to 15 percent of qualified enhanced oil recovery costs (see Q 7885).