Intangible Drilling Costs

[sali]

I want to revisit the IDC deduction. I read previous posts on this subject, but want to ask about my specific instance. My client received a 2013 K-1, form 1065, for a oil and gas company and it is marked "limited partner or other LLC member". This is its first year. Can he take the intangible drilling cost deduction (reported as Line 13, Code J, $115,500) in full in 2013? My software is treating it as passive loss and offsetting it against passive income, then carrying over the unallowed loss. Even though the K-1 is checked as "Limited Partner" which says to me passive, can IDC be treated as if he were active and be taken? Thank you.

[Roland Slugg]

Yes, a limited partner can deduct IDCs. However, he can also elect to amortize them over 60 months. (Code §263(c)) If he chooses the deduction, the amount deducted is also a tax preference item, but if he elects to amortize them, the current year's deduction is not a tax preference item.

Overriding all this, however, are the PAL deduction rules. As a limited partner your client's investment is, by definition, a passive activity, and the PAL rules apply. It looks like your tax prep software is trying to handle it correctly.

Please refer to the instructions for Schedule K-1 (Form 1065), line 13, Code J.

[JON]

Idc

So if you take the entire deduction in the year the resulting loss in excess of basis is carried forward, waiting for passive income to offset it. If the loss causes AMT, you better look at amortizing to see if that does not help the AMT.. Right Roland...

[sali]

What if the initial investment and ownership is considered a "working interest" (per client)? Does this change the ability to take IDC against active income such as wages?

[David1980]

Pub 925 lists under "Activities That Are Not Passive Activities" a "2. A working interest in an oil or gas well which you hold directly or through an entity that does not limit your liability (such as a general partner interest in a partnership). It does not matter whether you materially participated in the activity for the tax year."

That sounds like what the taxpayer expects, no doubt how the investment was described to them when they bought in as well. However, you specified that the partner is a limited partner or LLC member. So, I guess question is, does the entity limit the liability or not? Then of course you still have at-risk limitations.

[sali]

Thank you for the information and IRS pub.

[DaveO]

I have seen these where the K-1 is marked as a general partner the first year allowing deduction of IDC costs. Then in the second and subsequent years the limited partner box is checked. If they are treated as a general partner then income in later years (I know that rarely happens but…) will be subject to SE tax. In the 2013 filing season I saw a client who bought a working interest is a single well. First time I had seen this, it is reported on “C”. A CPA with the drilling company provided me with quite a bit of information. I will have to compute the depletion going forward based on the engineering studies provided, can’t wait.