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Anne, Master Tax Preparer
Category: Tax
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Experience:  Enrolled Agent with 25 Years Experience specializing Individual and Small Businesses
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Which form do I use to deduct dry hole expense for drillg for

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Which form do I use to deduct dry hole expense for drillg for oil when no K-1 is involved?

Whether this expense comes to you on K1 or not, the income (royalties) from any oil and the expenses associated with those wells is reported on Form1040(ScheduleE Supplemental Income and Loss.

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Customer: replied 6 years ago.
There are no royalties. I only have the dry hole expense.
I understood that. The dry hole expenses still are reported on Schedule E.

I hope this helps.
Customer: replied 6 years ago.

I called the IRS and this is what I was told by them.

I have to deduct the "dry hole Expense" on Sch C under other expenses since apparently a 1099 was issued for $120 in nonemployee compensation.

If you disagree, please tell me.

Where would I deduct it on the Sch E?

I need some additional information before I can answer you.

Was the $120 in box 7 of the 1099 and why was it paid to you? Are you in the business of finding oil wells? (From your original question, I realize this is doubtful, but I need to know why the 1099 was issued and what box the $120 was in)

In other words....who paid you this money and why?
Unless you are in the business of drilling wells, the cost of the dry hole drilling is truly a Schedule E entry, however, it is not unusual for someone to receive a 1099MISC in error, usually due to someone not understanding how this should be reported.

Anytime you receive income listed on a 1099MISC in box 7, IRS's position is that the income should be reported on Schedule C. The reason they want it reported there is so you can pay the SE tax. Even though you would not owe SE tax since your income was only $120, you want this reported correctly so that should you ever start receiving royalties, you will not pay SE tax on them (royalties are also reported on Schedule E)

That is why I asked the follow up questions, but in answer to your question does the fact that the IRS stated that this should be reported on Schedule C and I stated it should be reported on Schedule first impression is no.....but I truly need the additional information of who paid you and why before I can state that with 100% confidence.
Customer: replied 6 years ago.

I am in the business of investing in oil & gas driling ventures. In the past all transactions have been partnerships and I would receive a K-1 and use the Sch E. That is why I am confused about this.

This venture was call a subscription. I just received the 1099 Misc Income with box 7 showing non employee compensation from Grand Southern Resources ( a drilling company). The compensation was for the minute amount of oil & gas collected during the drilling process.

Thank you so much for your time with this matter.

Ok, I don't often run into people that do this as their business. This is considered to have a "working interest" in the well, and IRS is correct that this is reportable on Schedule C. See below:
  • Working Interests: This is by far the riskiest and most involved way to participate in an oil and gas investment. All income received in this form is reportable on Schedule C of the 1040. Although it is considered self-employment income and is subject to self-employment tax, most investors who participate in this capacity already have incomes that exceed the taxable wage base for Social Security. Working interests are not considered to be securities and therefore require no license to sell. This type of arrangement is similar to a general partnership in that each participant has unlimited liability. Working interests can quite often be bought and sold by a gentleman's agreement.
Even if you don't consider what you do to be a "working interest" the fact that you are in the business of investing in oil & gas drilling ventures makes this Schedule C income.

Additionally, drilling costs normally must be capitalized over 7 years, but you do have the option of writing off the entire cost as long as you include a note with your return stating that you are making the election to take the loss all in one year. If you choose to capitalize the cost, you will do so by filing Form 4562Depreciation and Amortization (Including Information on Listed Property) along with your 2009 Form 1040 (Schedule C)
See below:.

Nonproductive well. If you capitalize your IDCs, you have another option if the well is nonproductive. You can deduct the IDCs of the nonproductive well as an ordinary loss. You must indicate and clearly state your election on your tax return for the year the well is completed. Once made, the election for oil and gas wells is binding for all later years. You can revoke your election for a geothermal well by filing an amended return that does not claim the loss.

Intangible Drilling Costs

I hope this helps.
Anne, Master Tax Preparer
Category: Tax
Satisfied Customers: 2326
Experience: Enrolled Agent with 25 Years Experience specializing Individual and Small Businesses
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