Ronald R. Levy and Esther Levy, Petitioners-Appellants/cross-Appellees v. Commissioner of Internal Revenue, Respondent-Appellee/cross-Appellant

Ronald R. Levy and his wife Esther are two Beverly Hills residents who invested in an oil drilling venture involving Moray Oil Company, Inc. (Moray) and its wholly owned subsidiary Dubros, Inc. (Dubros), two Kansas corporations. Levy entered into three limited partnership agreements with Moray, covering two leases, known as the Baker and Croxton leases, in Linn County, Kansas. The partnership agreements provided that Moray would be the general and Levy the limited partner in each partnership. Levy would make a capital contribution consisting of a cash payment and a negotiable note secured by an interest in production proceeds. Dubros was .to drill the oil wells under a turnkey contract with Moray. All income and expenses were allocated under the agreement to Levy, with Moray retaining overall management and control, a 25% working interest in the Baker lease, and a royalty interest (convertible to a 50% working interest) in the Croxton lease.

Levy, a cash basis taxpayer, filed a timely election to expense rather than capitalize intangible drilling and development costs (IDCs) under I.R.C. § 263(c) and Treas. Reg. § 1.612-4 (a). He claimed partnership loss deductions for IDCs…