Tangible Completion Cost

In Driftwood Basin Program's functional allocation arrangement, investors fund 100% of IDC and the sponsor funds 100% of tangible completion costs. Which party is entitled to currently deduct the IDC against other income, assuming sufficient basis and at-risk amounts?

1. A.The sponsor, because the sponsor organizes the program and receives the tax benefits as compensation.Wrong. Tax deductions follow economic cost-bearing, not sponsor status.
2. B.The investors, because the current IDC deduction follows whoever actually bears that cost.Correct. Investors funded the IDC under functional allocation, so they hold the deduction.
3. C.Both parties split the IDC deduction in proportion to their revenue interests.Wrong. The IDC deduction is not allocated by revenue share; it follows the cost-bearing party.
4. D.Neither party may deduct IDC currently; it must be capitalized and depreciated like the tangible costs.Wrong. IDC is generally currently deductible by the party bearing it, unlike tangible costs, which are capitalized.

Why: The current IDC deduction follows whoever actually bears that cost economically -- here, the investors -- independent of how program revenue is split.

Bramblewood Program's sponsor funds 15% of every cost category. A well costs $300,000 in IDC and $150,000 in tangible completion costs. How much of the IDC does the sponsor fund in dollars?

1. A.$45,000Correct. 15% x $300,000 IDC = $45,000.
2. B.$67,500Wrong. This applies 15% to the combined $450,000 of total cost rather than to IDC alone.
3. C.$22,500Wrong. This applies 15% to the $150,000 tangible completion cost instead of the $300,000 IDC.
4. D.$255,000Wrong. This applies the investors' 85% share to the IDC instead of the sponsor's 15%.

Why: The sponsor's 15% percentage applies to the IDC category specifically: 15% x $300,000 = $45,000.

Under Driftwood Basin Program's functional allocation arrangement, investors fund 100% of IDC and the sponsor funds 100% of tangible completion costs. Under Marrow Creek Program's carried interest arrangement, the sponsor is carried for its share of IDC, to be repaid from the sponsor's future revenue once the well produces. A dry hole is drilled in each program; the dry hole never produces any revenue. In Marrow Creek, who ultimately bears the sponsor's carried share of the dry hole's IDC?

1. A.The sponsor still bears it eventually, because a carry only defers cost, it never eliminates it.Wrong. A carry is repaid only out of production revenue; with no production ever, there is nothing to repay it from.
2. B.In Driftwood Basin, the sponsor bears the dry hole's IDC because functional allocation shifts all dry hole risk to the sponsor.Wrong. Under functional allocation, investors fund 100% of IDC, including on a dry hole; the sponsor's category is tangible completion costs, which a dry hole never incurs.
3. C.In Marrow Creek, no one bears the cost, because a dry hole automatically voids all cost obligations in a carried interest arrangement.Wrong. There is no such rule; the cost was already advanced and simply cannot be recouped absent production revenue.
4. D.The carrying party -- the investors who advanced it -- ultimately absorbs that cost.Correct. With no production revenue ever generated, the advance can never be repaid, so the carrying party bears the loss.

Why: Because the carry can only be repaid out of production revenue and the well never produces any, the sponsor's carried share is never repaid. The carrying party -- the investors who advanced it -- ultimately absorbs that cost.

A drilling program uses functional allocation: limited partners fund intangible drilling costs and the general partner funds tangible completion costs. After the well is producing, downhole conditions require a re-drilling procedure, an intangible cost, and separately require replacing damaged production equipment, a tangible cost. Who bears each of these two post-completion costs under the program's functional allocation arrangement?

1. A.The limited partners bear the re-drilling cost as an intangible cost, and the general partner bears the equipment replacement as a tangible cost, consistent with the original functional allocationCorrect. Functional allocation follows cost classification consistently, so intangible and tangible costs continue to fall to the same parties as they did originally.
2. B.The general partner bears both costs, because all post-completion costs are treated as operating expenses assigned to the operatorWrong. Functional allocation continues to follow cost classification after completion; it does not shift all post-completion costs to the operator regardless of type.
3. C.The limited partners bear both costs, because functional allocation assigns all costs incurred after production begins to the party who originally funded intangible costsWrong. This misstates the rule; functional allocation assigns costs by classification, not by shifting all post-production costs to whoever funded intangible costs originally.
4. D.Both costs are shared proportionally between the two parties regardless of classification, because functional allocation only applies to the original drilling costsWrong. Functional allocation is not limited to the original drilling phase; it continues to govern how costs are assigned by classification throughout the well's life.

Why: Functional allocation assigns costs by their tax character, intangible or tangible, not by when in the well's life they are incurred. The re-drilling procedure is an intangible cost, so it falls to the limited partners under the same arrangement that assigned the original intangible drilling costs to them. The equipment replacement is a tangible cost, so it falls to the general partner under the same arrangement that assigned the original tangible completion costs. The fact that both costs arise after the well is already producing does not change which party bears them; what matters is the cost's classification, not its timing.