DEVELOPMENT OF OIL AND GAS PROPERTIES - Collins College ...

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Nov 8, 2013 (3 years and 11 months ago)

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DEVELOPMENT


OF OIL AND GAS
PROPERTIES

PATRICK HENNESSEE

THE NATURE OF IDC



EXPENDITURES


WITHOUT A SALVAGE VALUE


FOR DRILLING &


PREPARATION FOR PRODUCTION

IDC DEFINED

REG. SEC. 1.612
-
4


EXPENDITURES MADE BY AN
OPERATOR

FOR WAGES, FUEL,
REPAIRS, HAULING, SUPPLIES, ETC.,
THAT ARE (1)
INCIDENT

TO AND
NECESSARY

FOR THE
DRILLING

OF
WELLS AND THE
PREPARATION FOR
PRODUCTION
OF OIL OR GAS AND (2)
DO

NOT

HAVE A
SALVAGE VALUE
.















DRILLING TO

TOTAL DEPTH









CEMENTING

CASING









Fracking &

Perforating

the formation



COMPLETING THE

WELL

















Oil

Drilling Mud

Drill Stem

Bit Cuttings

Drill Bit

DRILLING

How Wells Are Completed


Evaluate Formation


Isolate the Formation


Stimulate Well


Install Production Equipment

Self

Potential

Resistivity

WELL LOGGING

Drill Stem

Packer

Formation Tester

DRILL STEM TEST

CEMENTING

Drilling Mud

Casing

Cement


Oil

Flows

Hydraulic Pressure

Fractures Rock

HYDRAULIC FRACTURING

Sand lodges

in fractures

WORKOVER COSTS


REMEDIAL OPERATION TO
INCREASE PRODUCTION IN A
PRODUCING WELL


GENERALLY:


COSTS FOR IMPROVING, MAINTAINING, OR
SUSTAINING PRODUCTION FROM
CURRENTLY PRODUCTIVE RESERVOIRS =
OPERATING EXPENSE


COSTS TO OBTAIN PRODUCTION FROM
NEW RESERVOIR = IDC





OFFSHORE DRILLING

OFFSHORE MOBILE RIGS

OFFSHORE MOBILE RIGS


ISSUE: G&G VS. IDC


IF WELL COULD ACTUALLY
PRODUCE OIL IF DESIRED


TREAT AS IDC

STANDARD OIL CO., 68 TC 325

SUN COMPANY, 74 TC 1481






OFFSHORE DRILLING

PLATFORMS

OFFSHORE

DRILLING

PLATFORMS


IDC


COSTS OF DESIGNING AND
CONSTRUCTING THE PLATFORM


TRANSPORTING THE PLATFORM TO
THE SEA


NO DEDUCTION FOR ACTUAL
MATERIALS USED IN CONSTRUCTION

Problem 1


Classify the expenditures in problem
1 as:


Leasehold costs (capital expenditures)


Intangible Drilling Costs (IDC)


Lease and well equipment (Eq.)


Lease operating costs (LOE)

____

1. Research of lease location by engineer, geologist, etc.

____

2. Administrative costs in connection with drilling contracts.

____

3. Surface casing.

____

4. Cost of switcher, pumper, and gauger to operate the wells.

____

5. Cost of minor repair of pumps, tanks, etc.

____

6. Equalization payments of a unitization when paid in



connection with equipment.

____

7. Survey and seismic costs to locate a well site on leased



property.

____

8. Costs of drilling.

____

9. Grading, digging mud pits, and other dirt work to prepare



drill site.

____

10. Geological and geophysical expenditure leading to the



acquisition or retention of an oil and gas property.

____

11. Expenses in connection with leasing the property from the


landowner.

____

12. Cost of constructing roads or canals to drill site.

____

13. Surface damage payments to landowner around the drill site.

____

14. Crop damage payments to landowner due to transporting the


drilling rig to and from the drill site.

____

15. Cost of well casing.

____

16. Grading existing roads in order to transport oil to the refinery.

____

17. Treat
-
o
-
lite and other materials and supplies consumed in


operating the lease.

____

18. Salt water disposal equipment and well.

____

19. Costs of setting the rig on drill site.

____

20. Transportation costs of moving rig.

____

21. Technical services of geologist, engineer, and others engaged



in drilling the well.

____

22. Legal costs of securing lease and clearing title.

____

23. Legal fees incurred to obtain access to the property and to



obtain easements, etc.

____

24. Drilling mud, fluids, and other supplies consumed in drilling



the well.

____

25. Transportation of drill pipe and casing.

____

26. Cementing of the casing (but not the casing itself).

____

27. Rent of special equipment and tanks to be used in



____

28. Transportation of tubing to supply yard but not from



supply yard to well.

____

29. Cost of production tubing.

____

30. Pulling sucker rods, pump, and cleaning the well.

____

31. Utilities to run pump.

____

32. Severance taxes on oil produced.

____

33. Cost of well head and "Christmas Tree."

____

34. Perforating the well casing.

____

35. Logging costs.

____

36. Costs of removing rig from location.

____

37. Dirt work in cleaning up the drill site.

____

38. Lease bonus paid to landowner.

____

39. Purchase price of an existing lease.

____

40. Costs of pumps and motors including transportation.

____

41. Cost of tanks, flow lines, treaters, separators, etc., including



transportation.

____

42. Depreciation on equipment used on the lease.

____

43. Rental on lease equipment.

____

44. Dirt work for tanks and production equipment.



____ 45. Cost of acidizing, fracturing the formation, and other



completion cost.

____ 46. Seismic work to determine the size of the reservoir

or


reserves.

____ 47. Legal fees incurred in drafting contracts, division orders, etc.

____ 48. Travel incurred in acquiring lease.

____ 49. Swabbing costs to complete the well.

____ 50. Wells drilled for pressurizing the producing zones such as



water flooding.

____ 51. Laying pipelines, including dirt work and easements.

____ 52. Salaries for painting and cleaning on the lease.

____ 53. Installation costs of tanks and production equipment.

____ 54. Construction costs of trucks turnaround pad and overflow



pits at new tank battery.

____ 55. Bottom
-
hole contribution.

____ 56. Costs of plugging the well if dry.

____ 57. Costs of drill stem tests.

____ 58. Open hole testing.

____ 59. Rental payments to mineral owner when not based on



production.

____ 60. Remaining basis in equipment which is transferred to



another person under any type of reversionary agreement.

THE ELECTION


DEDUCT IN 1ST YEAR IDC IS
INCURRED


NO FORMAL STATEMENT
REQUIRED


BUT MAKE ONE

STATEMENT


“TAXPAYER HEREBY ELECTS TO
EXPENSE ALL INTANGIBLE
DRILLING AND DEVELOPMENT
COST OF OIL AND GAS WELLS
UNDER THE AUTHORITY OF SEC.
263(c) AND REG. SEC. 1.612
-
4(a).”

PARTNERSHIP


PARTNERSHIP MAKES THE
ELECTION


NOT THE INDIVIDUAL PARTNERS


TO BE SAFE:


ATTACH A STATEMENT TO THE 1065

SECOND ELECTION


USED ONLY WHEN TAXPAYER
ELECTED TO CAPITALIZE IDCs


ELECTION TO EXPENSE DRY
HOLES


STATEMENT ON THE RETURN


FIRST YEAR TAXPAYER DRILLS A DRY
HOLE


IDC
-

PROBLEM 2


Kyle O'Tracy invested $10,000 in an oil and gas
venture on December 18, 19X6. $7,000 of this
represented IDC, $2,500 was for equipment and $500 was
for leasehold cost. The well was completed on December
28, 19X6 as a producer. This was the first time Kyle had
invested in an oil and gas well. Kyle started to file his tax
return for 19X6 (at 8:00 p.m., April 15, 19X7) when his
good friend Mable called and invited him to a party that
started at 9:00 p.m. Kyle, being more of a party animal
than Spuds Mckinsey quickly completed Form 4868,
Application for Automatic Extension of Time to File U.S.
Individual Income Tax Return and dropped it in the mail
on his way to the party.


What is Kyle' status regarding his IDC election
when he finally files his return on August 15, 19X7?



IDC
-

PROBLEM 3


Sean Patrick, an individual (who has never been
involved in the oil and gas business before) acquired an
oil and gas lease from his brother on March 20, 19X6.
Sean decided to develop the property late in 19X6 and a
well was spudded in on December 18, 19X6. By the end
of the year Sean, a cash basis taxpayer, had spent
$28,000 in drilling cost. The well was completed by mid
January of 19X7. Sean spent a total of $178,000 in drilling
and completion cost and $42,000 in equipping the well.
Because Sean had very little taxable income in 19X6, he
decided to expense the entire well in 19X7. Therefore, on
his 19X6 return, Sean had reported nothing regarding his
oil and gas activities.


What do you think Sean's status regarding the IDC
election is at this point?


SECTION 59(e) ELECTION


ONLY IF TAXPAYER HAS ELECTED
TO EXPENSE IDC


THIS ELECTION IS USED TO
CAPITALIZE ANY AMOUNT OF IDC


AND AMORTIZE OVER 5 YEARS


AMOUNT CAPITALIZED IS NOT TAX
PREFERENCE IDC


PARTNER MAKES ELECTION

INTEGRATED OIL
COMPANIES


MUST CAPITALIZE 30% OF THEIR
DOMESTIC IDC


AMORTIZE THIS OVER 60 MONTHS


BEGINNING WITH THE MONTH THAT
COSTS ARE INCURRED OR PAID

Electing Large Partnerships


1997 Act
-

Simplification


Electing Large Partnerships
--

100


Depletion


AMT


Section 29 Credit


IDC


Generally same as before
-

partnership
level


“Disqualified Person”
-

retailer, refiner


Permitted to make their own
§
59(e) election


FOREIGN IDCs


CAPITALIZE ALL PRODUCTIVE IDC


AMORTIZE OVER 10 YEARS



OR


RECOVER ADD TO COST BASIS
AND USE COST DEPLETION TO

WHEN TO DEDUCT IDC


GENERAL RULES


ACCRUAL BASIS


DEDUCT IN YEAR INCURRED


CASH BASIS


DEDUCT IN YEAR PAID IF COST HAVE
BEEN INCURRED

PREPAID IDC



IMPORTANT FACTORS


NOT A MERE DEPOSIT


NOT RESULT IN A MATERIAL DISTORTION OF
INCOME


BONAFIDE BUSINESS PURPOSE


MUST BE REASONABLE AMOUNT


LEGALLY REQUIRED TO MAKE THE PREPAYMENT


HELPFUL TO HAVE A DATE WHEN DRILLING IS TO
BEGIN


HELPFUL IF ALL WORKING INTEREST OWNERS
PARTICIPATE IN THE PREPAYMENT


HELPFUL IF CONTRACT IDENTIFIES THE WELLS TO
BE DRILLED

PREPAID IDC TO A “TAX SHELTER”
MAY BE DEDUCTED WHEN:



CASH IS PAID & IT IS
NOT

RAISED BY
LOANS SECURED BY THE TAX
SHELTER’S ASSETS OR LOANS
ARRANGED BY PERSONS INVOLVED
WITH THE TAX SHELTER


AND


IF THE WELL IS SPUDDED DURING THE
FIRST 90 DAYS OF THE FOLLOWING
YEAR
.

TAX SHELTER DEFINED


AN ENTERPRISE (other than a C Corp.)
REQUIRED TO BE REGISTERED WITH
STATE OR FEDERAL AGENCIES;


A PARTNERSHIP THAT 35% OF ITS
LOSSES ARE ALLOCABLE TO LIMITED
INTEREST; OR


AN ENTITY OR PLAN WHO'S PRINCIPAL
PURPOSE IS AVOIDANCE OR EVASION
OF TAXES

IDC
-

PROBLEM 4



Elizabeth paid $40,000 for a limited partnership
interest in a drilling program set up by Big Oke Oil
Company which also became general partner. In
December 19X7, Elizabeth's $40,000 investment was used
to make four different types of prepayments:



1.

Prepayments were made to independent third
parties under footage and daywork drilling contracts. The
amounts paid were based on estimates of how much it
would cost to drill the well on a cost per foot or per day
basis. The partnership had the right to cancel the contract
at any time. If it did so, it would be entitled to a refund of
the repayment reduced by whatever amount the
contractor had by then earned under the contract for
services actually performed.




2.

Prepayments were made to independent third
parties under turnkey drilling contracts. These contracts
were for a flat fee and were not refundable. If, however, a
well was canceled, the prepaid amount was to be applied
to the drilling of a different well.

IDC
-

PROBLEM 4
--

continued

3.

Prepayments were made to independent third
parties on well servicing contracts. The amount of the
prepayment was based on an estimate of the service to be
provided under the contract. The contracts could be
canceled at any time, in which case the prepayment was
refundable except to the extent earned by the contractor
at that time.



4.

Prepayments were made to Big Oke under a
contract requiring Big Oke to supervise the drilling of the
wells provided for in the turnkey, footage and daywork
contracts. The prepayment was based on an estimate of
the work to be done by Big Oke. These prepayments
were not refundable.



Work on most of the wells called for under the
turnkey, footage, and daywork contracts was not
commenced until the following year. The IRS will
concede that all prepayments involved will qualify as IDC.


Can Elizabeth (who is on the cash basis as is the
partnership) can claim the entire amount of her $40,000
investment as a deduction on her 19X7 return?


IDC
-

PROBLEM 5


On December 18, 19X6, Kyle O'Tracy, cash basis,
calendar year taxpayer, paid $150,000 to Big Oke
Partnership (also cash basis, calendar year entity) for a 20%
limited partnership interest. Kyle's $150,000 was raised as
follows:

.....$50,000 was his own money.

.....$50,000 from a loan arranged by Big Oke's general


partner.

.....$50,000 for a loan from Penny Square Bank (an unrelated


third party.



The well was spudded in on March 1, 19X7. Big Oke
paid the $150,000 to the drilling contractor on a turnkey
contract with a valid business purpose by the end of 19X6.
Can Kyle deduct any or all of the $150,000 payment in 19X7?


WHO CAN DEDUCT IDC?


ONLY WORKING INTEREST OWNERS


DURING THE COMPLETE PAYOUT
PERIOD


MUST PAY FOR THE IDC


AND ONLY FOR THE COST
ATTRIBUTABLE TO THEIR FRACTIONAL
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