Simon acquires an interest in an oil property for $50,000. Intangible drilling costs (IDCs) in the initial year are $10,000. Cost depletion is $5,000 if the IDCs are expensed and $6,000 if the costs are capitalized. Percentage depletion is $15,000 if the IDCs are expensed and $20,000 if the costs are capitalized. The difference in the percentage depletion amounts is due to the 100% taxable income limitation.
a. What method (i.e., expensing or capitalization and amortization) should be elected for the treatment of the IDCs in the initial year if Simon wants to maximize his deductions?
b. Why are intangible drilling costs expensed by most taxpayers?