Discussion:Sch K-1 reference to Sec. 59(e)(2) expenditures

Sch K-1 line 13I reports $5,000. The description is Sec. 59(e)(2) expenditures. Reading this code section leads me to believe that I claim the deduction for regular tax but only deduct $500 per year over 10 years for AMT. However, the reference is to an election. Do I have the option of claiming the full deduction?

Do I deduct this expense on Sch E?

Thank you for any help.

The IDC alt min adjustment is found in 57(a)(2). The exception to the tax preference calculation for independent producers can be found in 57(a)(2)(E). However, notice the limitation on the IDC benefit contained in that same subparagraph.

Thus, the short answer to your question is that the IDC deduction for most small producers with substantial non-oil and gas income is more often than not the same for regular tax and AMT purposes.

1. My client’s allocations on his Schedule K-1 related to oil and gas are passive since my client is a limited partner.

2. The AMT adjustment related to IDC is governed by a convoluted calculation under Sec 57(a) that involves the difference between the IDC deduction and the amount of the deduction if those costs were capitalized and amortized over ten years. Thankfully, unless the adjustment exceeds a certain threshold, the AMT adjustment does not apply.

3. The AMT issue may be avoided entirely by making the election to amortize the IDCs over 60 months under Sec 59(e). Reg Sec 1.59-1(b) specifies the details that must be stated in the election statement, which is interesting, because if the taxpayer does not claim the deduction for IDCs in his first year of having IDCs, then Reg Sec 1.612-4(d) states that the taxpayer is deemed to have elected to recover the costs through depletion. We seem to wind up in the same place, regardless of whether a statement is filed. The only difference that I see is that Reg Sec 1.612-4(d) refers to depletion and Reg Sec. 1.59-1(b) refers to amortization.

4. Not making the election to amortize the costs means the taxpayer is making an election to expense the costs under Sec 263(c). Again, if a certain threshold applies, there will be an AMT adjustment.

5. Reg Sec 1.612-4(d), referred to by Reg Sec 1.263(c)-1, discusses how to make the election. It is made by claiming the deduction. No election statement is required. Failure to claim the expense is deemed an election to recover the costs through depletion.

6. The taxpayer has the option to elect to deduct IDCs only in the first year that he has IDCs. Under Reg Sec 1.612-4(e), the taxpayer’s treatment of IDCs in future years follows his treatment in the first year that he has IDCs.

7. Whatever the method of deducting the IDCs, whether expensing immediately under Sec. 263(c) or amortizing under Sec. 59(e), the deduction must be recaptured as ordinary income when the property is sold. Example (3) of Reg Sec 1.1254-5.

Thank you for any help!