What are tangible drilling costs?
Recovered through depreciation
Tangible drilling costs are amounts spent on well equipment that has salvage value, such as casing, tubing, pumps, and tanks. Treas. Reg. §1.612-4(c) excludes them from the IRC §263(c) election, so they are capitalized and recovered through depreciation. For property acquired after January 19, 2025, P.L. 119-21 made 100% bonus depreciation under §168(k) permanent, so many of these costs can be deducted in the year placed in service unless you elect out.
Reviewed by Ebot Mbi, CPA, EA · Last reviewed · Law and figures current as of September 17, 2026
Key takeaways
- Equipment with salvage value is capitalized, not deducted as intangible drilling costs.
- Qualifying equipment acquired after January 19, 2025 is eligible for 100% bonus depreciation.
- You can elect out of bonus depreciation by class and use regular MACRS, typically 7-year property for oil and gas production assets.
- Depreciation is recaptured as ordinary income under §1245 when the equipment is sold.
- Classification between tangible and intangible must follow the regulation's salvage-value test.
What it is
A well's costs fall into two groups. Intangible drilling costs are consumed in drilling and have no salvage value. Tangible costs buy equipment that can be recovered and reused or sold: casing, tubing, wellhead equipment, pumping units, separators, tanks, and flow lines.
Tangible costs are capital expenditures. Since P.L. 119-21, most of them can still be deducted quickly through bonus depreciation, but they follow the depreciation rules rather than the IDC election.
The same well can involve both kinds of cost in a single invoice. Drilling contractors often bill labor, rig time, and materials together, so the cost records must be broken down to apply the correct treatment to each item.
What the law says
Treas. Reg. §1.612-4(c) provides that the option to expense intangible drilling and development costs does not apply to expenditures for physical property that has a salvage value, such as tools, pipe, and equipment. These costs are recovered through depreciation under IRC §168.
P.L. 119-21 amended §168(k) to provide a permanent 100% additional first-year depreciation deduction for qualified property acquired after January 19, 2025, as explained in IRS Notice 2026-11. Taxpayers may elect out for any class of property, and a transitional election allows 40% instead of 100% for property placed in service in the first tax year ending after January 19, 2025. Oil and gas production equipment generally falls in asset class 13.2 of Rev. Proc. 87-56, with a 7-year recovery period.
Requirements and tests
To recover tangible costs correctly:
- Classify each cost using the salvage-value test in Treas. Reg. §1.612-4, not the invoice label.
- Determine when the equipment was acquired and placed in service to confirm bonus eligibility.
- Decide by property class whether to take bonus depreciation or elect out.
- Use the correct recovery period and convention if you elect out, including the mid-quarter convention when it applies.
- Keep the equipment separate from depletable leasehold basis.
- Track depreciation for §1245 recapture on sale, and consider the excess business loss and at-risk limits on the resulting loss.
How it works
If bonus depreciation applies and you do not elect out, the full cost of qualifying equipment is deducted in the year placed in service. If you elect out, the cost is recovered over the recovery period; for 7-year property using the half-year convention, the first-year rate is 14.29%.
A large first-year deduction increases the year's business loss, which can be limited by the excess business loss rule for noncorporate taxpayers ($256,000, or $512,000 joint, for 2026). When equipment is sold or salvaged, depreciation taken is recaptured as ordinary income to the extent of gain.
Leasehold costs, such as lease bonuses and acquisition costs, are neither IDCs nor equipment; they are depletable basis recovered through depletion. Keeping three separate cost pools, intangible, tangible, and leasehold, is the foundation of correct reporting.
Bonus depreciation also affects later years. Because the full cost is deducted up front, there is no further depreciation in later years, and the entire amount can be recaptured as ordinary income if the equipment is sold for more than its remaining basis.
State depreciation rules can differ from federal rules. Texas has no personal income tax, but other states where wells are located may not follow federal bonus depreciation.
Assumptions: Tax year 2026; calendar-year taxpayer holding a working interest directly.; Tangible costs: $100,000 pumping unit and $50,000 casing, acquired and placed in service in 2026 under contracts signed in 2026.; Assumed to be 7-year MACRS property (asset class 13.2); half-year convention applies if bonus is elected out.; Loss limits are ignored for this computation.
| Option 1: 100% bonus depreciation in 2026 | $150,000 |
|---|---|
| Option 2: elect out, 2026 MACRS depreciation (14.29% × $150,000) | $21,435 |
| Option 2: cost left to recover in 2027 and later | $128,565 |
| §263(c) IDC election applied to this equipment | Not allowed |
The equipment can be deducted in full in 2026 through bonus depreciation, or recovered over seven years if the taxpayer elects out; it is never an IDC.
Illustration only; not a projection of your results.
Risks and IRS scrutiny
Examiners review whether equipment was wrongly treated as intangible drilling costs, whether bonus depreciation was claimed on property acquired before the eligibility date or under a binding contract signed earlier, and whether recovery periods are correct. Misclassification can distort both depreciation and depletable basis and lead to adjustments, interest, and penalties.
When a well is plugged and abandoned, any remaining undepreciated basis in equipment that cannot be salvaged may be deductible, while salvaged equipment keeps its basis or is treated as sold.
Who it is not for
The rules on this page do not apply to royalty owners, who do not own well equipment. They are not a fit for anyone who plans to treat equipment costs as IDCs, or who cannot track acquisition dates and asset classes.
It is also not a fit for anyone who wants to spread deductions evenly but does not make the election out of bonus depreciation on a timely filed return, because the 100% deduction applies automatically unless you elect out.
How ebotCPA helps
We review your cost schedules, separate tangible from intangible costs, model bonus depreciation against electing out, and track recapture and loss limits.
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.
Frequently asked questions
Can tangible drilling costs be deducted in the first year?
Often yes, through 100% bonus depreciation for qualifying equipment acquired after January 19, 2025, but not through the IDC election.
What depreciation period applies to oil and gas well equipment?
Production equipment generally falls in asset class 13.2, with a 7-year MACRS recovery period.
Is casing a tangible or intangible drilling cost?
Casing has salvage value, so it is tangible equipment recovered through depreciation.
What happens when I sell well equipment?
Depreciation taken is recaptured as ordinary income under IRC §1245, to the extent of gain.
Have facts like these?
Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.