The deduction for depletion allows an owner or operator to compensate for the reduction in a product's resources. Examples of property that are subject to depletion deductions are oil and gas wells, mines, exhaustible natural deposits and timber. The two methods of computing depletion are discussed below. The taxpayer must use the method that produces the largest deduction.
- Percentage Depletion
- Cost Depletion
The percentage to be used depends on the mineral involved, and the range is 5 to 22%.
The percentage rate is then applied to the annual gross income derived from the resource.
Limits: Percentage depletion deduction may not exceed 50% of taxable income (oil and gas is the exception)
Oil and gas percentage depletion for small independent producers are allowed to deduct percentage depletion at a 15% rate for domestic oil and gas production, which is subject to taxable income limits.
Costs of natural resources are allocated to depletion over the period that makes up the life of the asset. Two requirements: a) estimate the total units of the mineral to be extracted; b) assign proportionate amount of the resource cost to the quantity extracted in the period (timber must use cost depletion).
Calculation:Investment to extract (x) [first year extraction in units/total estimated extraction in units]
Joe Riggs Oil Company invests $500,000 in a petroleum drilling operation where they estimate to extract 900,000 barrels of oil. In the first year, 100,000 barrels are extracted. Calculate the depletion deduction.
Depletion = $500,000 x [100,000 / 900,000] = $55,555
Sample Questions 1 - 7
InvestingThe overall economics of oil extraction is that there is money in it - both for extraction companies and their investors.
InvestingOil and gas investments can provide unmatched deduction potential for accredited investors.
InvestingLearn why natural gas is playing a larger role in the energy industry.
InvestingInvestors can find strong returns in oil and gas, but there are unique risks to the industry that can’t be overlooked. These are five of the biggest.
InvestingBefore investing in gas and oil stocks, consider such factors as political and geological risks.
InvestingThese funds allow everyday investors to get in on the action in this promising sector.
Financial AdvisorRetirees who don't want to deplete their nest eggs during a bear market should make sure to do the following.
InvestingOil and gas companies may look like a risky industry on the outside, but private equity investors have found reasons to regularly invest in these firms.
InvestingNow that the United States has increased oil production through shale oil and fracking, low oil prices can harm the U.S. oil industry and its workers.