Oil wells no K1

[Unregistered]

Client invested in drilling for oil and oil was not found. It was a Partnership but no Partnership return was done. What are the options as far as deducting these expenses? Has anyone dealt with this type of loss before? Client was told they would be able to deduct the entire loss in one year.

Thanks

[Unregistered]

Please....

Can someone answer any or all of this question?

[BOB W]

Partnership Returns..................

...............are not due until 04/16/06. You may file the 1040 now and file an amended return later, since it may be a loss. Or you can wait until the return is completed.

[Bees Knees]

I agree you need to wait for the K-1 from the partnership. If the partnership never gets off the ground and never issues a K-1, then take the amount invested and report it as a capital loss on Schedule D.

[JON]

Working Interests

The above is of the type where you report the activity on Schedule C. They still have to provide you with the information. I may disagree with Bees-IF the only reason you do not get a K-1 is because the partnership burned through the money trying to find oil I do not think it chages from 1040 Schedule E to Schedule D because the general partner had poor administrative procedures and did not get the return done...

[Unregistered]

New Info

The invested a certain amount of money for one dig to try and see if there was oil. There were other investors and this was not a spot they selected nor was it on their land. It turned out to be a dry hole. There will not be a K-1 because the oil company says they are not required to file a K-1 (the clients think he said because it is a short term relationship between their company and the investor). The company moves on to the next dig and the investors only pay for the one chance at striking oil.

[Bees Knees]

TTB, page 8-18, "What if the business never starts? Individuals. If an individual attempts to go into business and is not successful in starting the business, the expenses incurred in trying to establish the business fall into two categories:

1) Costs incurred before making a decision to acquire or begin a specific business are personal and nondeductible.....

2) Costs incurred in an attempt to acquire or begin a specific business are capital expenses and can be deducted as a capital loss."


You can't throw stuff on a Schedule C and call it a business if it never got off the ground. Drilling for oil and comming up dry means you never got off the ground. No product was ever produced, so no product could ever have been sold. This agrees with IRS Pub 535, page 31, middle column.

[JON]

Working oil interest

Not an expert but totally disagree - every working interest in the intial year throws off a loss usually equal to the investment. These are not caused by START UP costs, but by intial operations, drilling-maybe a dry hole. If one out of whatever spin profits later consider yourself lucky. This was all part of the oil tax break people, but has been there for a long time. I have a client who got into several three years ago. Massive write off year one in all and some small income now coming in 5 out of six. Working interest are C and defined by statute.

[Bees Knees]

I stand corrected.

It appears there is an exception to the start-up capitalization rules for intangible drilling and development costs.

Regulation Section 1.612-4(a) says: “(a) OPTION WITH RESPECT TO INTANGIBLE DRILLING AND DEVELOPMENT COSTS. In accordance with the provisions of section 263(c), intangible drilling and development costs incurred by an operator (one who holds a working or operating interest in any tract or parcel of land either as a fee owner or under a lease or any other form of contract granting working or operating rights) in the development of oil and gas properties may at his option be chargeable to capital or to expense. This option applies to all expenditures made by an operator for wages, fuel, repairs, hauling, supplies, etc., incident to and necessary for the drilling of wells and the preparation of wells for the production of oil or gas. Such expenditures have for convenience been termed intangible drilling and development costs. They include the cost to operators of any drilling or development work (excluding amounts payable only out of production or gross or net proceeds from production, if such amounts are depletable income to the recipient, and amounts properly allocable to cost of depreciable property) done for them by contractors under any form of contract, including turnkey contracts. Examples of items to which this option applies are, all amounts paid for labor, fuel, repairs, hauling, and supplies, or any of them, which are used:

(1) In the drilling, shooting, and cleaning of wells,

(2) In such clearing of ground, draining, road making, surveying, and geological works as are necessary in preparation for the drilling of wells, and

(3) In the construction of such derricks, tanks, pipelines, and other physical structures as are necessary for the drilling of wells and the preparation of wells for the production of oil or gas.

In general, this option applies only to expenditures for those drilling and developing items which in themselves do not have a salvage value. For the purpose of this option, labor, fuel, repairs, hauling, supplies, etc., are not considered as having a salvage value, even though used in connection with the installation of physical property which has a salvage value. Included in this option are all costs of drilling and development undertaken (directly or through a contract) by an operator of an oil and gas property whether incurred by him prior or subsequent to the formal grant or assignment to him of operating rights (a leasehold interest, or other form of operating rights, or working interest); except that in any case where any drilling or development project is undertaken for the grant or assignment of a fraction of the operating rights, only that part of the costs thereof which is attributable to such fractional interest is within this option. In the excepted cases, costs of the project undertaken, including depreciable equipment furnished, to the extent allocable to fractions of the operating rights held by others, must be capitalized as the depletable capital cost of the fractional interest thus acquired.