7885 / What is the enhanced oil recovery credit?

The enhanced oil recovery credit is a credit equal to 15 percent of a taxpayer’s qualified enhanced oil recovery costs in connection with certain certified enhanced oil recovery projects (generally referred to as tertiary recovery projects).¹ Because of the phase out tied to the “reference price” of crude oil, discussed below, this credit has not been important in recent years.

The credit is, in form, generally available for projects utilizing one or more qualified tertiary recovery methods located in the United States and begun after December 31, 1990.² Qualified enhanced oil recovery costs include amounts paid or incurred for tangible depreciable (or amortizable) property, intangible drilling and development costs, and qualified tertiary injectant costs.³ Costs paid for acquisition of an existing qualified enhanced oil recovery project are not eligible for the credit.⁴

The credit is phased out as the “reference price” for crude oil (the estimated average annual wellhead price per barrel for domestic crude oil, determined under IRC Section 45K(d)(2)(C)) exceeds $28 (adjusted by an inflation adjustment factor for taxable years beginning after 1991). The phaseout is equal to an amount that bears the same ratio to the amount of the credit as the amount by which the reference price for the calendar year preceding the calendar year in which the taxable year begins exceeds $28 (as adjusted for inflation) bears to $6.⁵ Because of the reference price and inflation adjustment factor, the credit was phased out completely in calendar years 2006 through 2024.⁶

Example. In 1993, F, the owner of an operating mineral interest in a property, incurred $100 of qualified enhanced oil recovery costs. The 1992 reference price was $34, and the 1993 inflation adjustment factor was 1.10. F’s credit in 1993 determined without regard to the phaseout for crude oil price increases was $15 ($100 × 15%). In determining F’s credit, $30.80 (1.10 × $28) was substituted for $28, and the credit was reduced by $8 ($15 × ($34 – $30.80)/6). Accordingly, F’s credit was $7.⁷

Any deduction otherwise allowable for items such as tangible depreciable property and intangible drilling and development costs taken into account in computing the enhanced oil recovery credit must be reduced by the amount of enhanced oil recovery credit attributable to the expenditure. Also, any increase in basis attributable to qualified enhanced oil recovery costs is reduced by the amount of credit claimed.⁸ Partners and S corporation shareholders must reduce the basis of their interests in a partnership or S corporation (but not below zero) to the extent any deduction is disallowed or any basis is reduced under the preceding rules in this paragraph.⁹