Operator of oil and gas lease, treatment of unreimbursed costs

Operator of oil and gas lease

The IRS today publicly released a “redacted” field advice memorandum* addressing several questions as to how a joint venture operator of an oil and gas lease is to treat certain unreimbursed costs. 20150701F (released February 13, 3015, and dated November 12, 2014)

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*Field advice memo documents are prepared by IRS field attorneys in the Office of Chief Counsel, are reviewed by an Associate Office, and are subsequently issued to IRS field or service center employees. The memo cannot be used or cited as precedent.

The field advice memo [PDF 279 KB] examines how the operator of the oil and gas lease (the property) is to treat certain unreimbursed expenses under the joint operating agreement.

As operator of the property, the taxpayer was responsible for day-to-day operations and was to pay the costs of all activities and operations, with each co-owner to reimburse the taxpayer in proportion to its participating interest share.

After an “event” occurred, the co-owners failed to pay their obligations under the joint operating agreement. The taxpayer paid the costs related to the event, and eventually the parties reached settlements resolving disputes related to the event.

The IRS field advice memo concludes that the unreimbursed expenses are deductible under section 162 and that the public policy doctrine and section 162(f) do not prevent the deduction of the unreimbursed expenses. The memo further concludes that the unreimbursed expenses:

  • Are not deductible as a loss under section 165 or as a bad debt deduction under section 166
  • Are not to be capitalized
  • Are not intangible drilling and development costs (IDCs) under sections 263 and 612

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