IDC---totally lost

[DaveinTexas]

Hello Friends,

I have an IDC question for you. I have a client who owns a working interest in an oil well. The K-1 from the 1065 states a $30 loss and a code I in box 13 and an amount of $19,444. The attached statement declares that this is the amount of the partner's intangible drilling costs. I know that these are basically tax shelters that never, at least I've never seen one, turn a profit.

My question is: If the client chooses to totally expense the IDC in the first year, where does the expense carry?

The K-1 instructions tells me to report it on line 28 H as a non passive loss. I hear others say to section 179 the IDC and carry it to the schedule C.

My other issue is the AMT adjustment related to expensing these IDCs. Is there an adjustment to make since the IDCs are in excess of actual earnings from this venture?

Hep me buddies. Let me know if I owe you anything for this...lol

[OldJack]

Taxpayers may capitalize, amortized over 60 months or expense Intangible drilling and development costs (IDC) of oil, gas and geothermal wells [Code §59(a), Reg 1.59-1, Reg 1.612-4, Reg 1.612-5]. In general IDC include only those costs that in themselves don't have a salvage value, such as labor and fuel.

Deducted IDC are recaptured on form 4797 as ordinary income on disposition of the oil or gas wells [Code §1254(a)(1)(A)].

If you do not elect to deduct your IDCs as a
current business expense, you can elect to de-
duct them over the 60-month period beginning
with the month they were paid or incurred.

[DaveinTexas]

Amt

Thanks Jack,

But do you know about the AMT adjustment? There is an IDC preference adjustment that must be made to AMT form 6251.

If I read the instructions correctly, this is how it works and maybe someone can correct me if I am wrong. The amount of the expensed IDC minus the amount that would be deducted if amortized over 10 years equals the amount of the adjustment. This is detrimental to my client. It will end up reducing his refund by approx. $4000.

Can anyone shed any light on this subject or do I have it correct?

TIA

[OldJack]

>>This is detrimental to my client. It will end up reducing his refund by approx. $4000.<<

But it is wonderful to other taxpayers and the government. Its a fact and your clients tax return would not be correct without the AMT tax calculation.

Well... I am not sure that it is 10 years without looking it up, but its not the whole 10 years worth that you compare to, it is 1 years worth on a straight line calculation (of the 10 years worth) compared to the current year expense taken. I expect you knew that and that is what you did.

If that is still a problem with AMT... maybe you should look at amortizing over 60 months instead of expensing.

[JohnH]

I'm resurrecting this thread because I ran across one of these and as much as I'd like to hand it back to the client, I thought it might be worth asking.

Taxpayer paid $17,000 in Nov 2008 for a 5% interest in an energy partnership. The K-1 is checked "General Partner" and shows a small loss on line 1 and $12,000 in Intangible Drilling Costs on Line 13-J. Before factoring in the above, taxpayer is liable for about $550 of AMT as the return stands.

As I see it, he can do one of the following:

1) Amortize the $12,000 over 60 months, which means a $400 deduction in 2008 and no AMT adjustment for this deduction. The remaining amount to amortize will be deducted at $2,400 per year with no AMT effect (unless the law changes).

2) Deduct the entire $12,000 in 2008 and take a $11,800 adjustment to AMT income in 2008 which basically puts them back at square 1, plus or minus a few pennies.

Can anybody enlighten me if I'm missing the boat here?

He's also asking how this will affect his taxes when the investment begins producing income. I'm telling him not to worry about that since there probably won't be any income.

[Burke]

I think you do have it right since in this case it looks like the TP is already subject to AMT even before doing the IDC calculation, if I am reading it right. Just reassure him that when it turns out to be a dry hole in 2009, he will be able to deduct the rest of his investment in full. If it should start producing income, he could take the 15% depletion deduction in addition to the IDC.

[JohnH]

Thanks Burke.
It's reassuring to know I'm on the right track.
Yes, the taxpayer is already subject to the AMT before the partnership even comes into the picture.

As an aside, it would seem to me that most people putting money into these partnerships would be subject to AMT, so the purported tax benefits of writing off the IDC in year 1 are somewhat misleading. But maybe my assumptions are all wrong.

[Burke]

Before answering your first post, I pulled the one I had done a couple of years ago. The MFJ income was slightly over $159,000 AGI, the IDC write-off was $12,000 and while the excess went to 6251, the regular tax was $311 more than the AMT tax, so it was advantageous to take it all. The working interest was purchased in Nov of one year and was terminated in Mar of the following year, as it turned out to be a dry hole, so it spread over 2 tax years. Had it turned up a dry hole in the first year, they could have deducted their entire investment. As it was, the balance at risk (less a small distribution which was described as "refund of completion costs") was deducted in that following year.