Intangible Drilling Costs

• Eligible intangible drilling deductions are costs of items with no salvage value. Costs associated with wages, fuel, repairs, hauling and all supplies related to drilling wells and preparing them for production, including some work done by contractors are eligible deductions. Costs associated with offshore drilling of exploratory boreholes are also allowable deductions as long as the drilled shaft can be used to produce oil (bring it to the surface) at some point in time.
  
  

Tangible Costs

• Tangible costs are the direct costs of drilling equipment. You can deduct 100 percent of these costs as long as they are depreciated over a 7-year period beginning with the year the equipment was put in use. Depreciation reflects the decreasing value of the asset, in this case equipment, through normal wear and tear.
  
  

Capitalized Costs

• Certain drilling costs can also be capitalized as long as these costs are allocated to depreciable property. Costs must have been paid out of proceeds from the production of oil, in contrast to taking on more debt. For tax and accounting purposes, capitalized costs are depreciated, depleted or amortized over time. In the case of drilled wells, the value of the property decrease over time as wells produce less oil. Non-productive wells can also be capitalized beginning with the tax return year the well was completed.
  
  

Deductions

• Deductions can be made as a current business expense or over a 60-month period beginning with the first month costs were incurred or paid. Take the deductions on Schedule C (Form 1040) of your returns for the first tax year eligible.