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.  

Computing Depletion:

  1. Percentage Depletion
  2. Cost Depletion

Percentage 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.

Cost Depletion
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).


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

Related Articles
  1. Investing

    Want To Start Trading Oil? Understand The Basics First

    The overall economics of oil extraction is that there is money in it - both for extraction companies and their investors.
  2. Investing

    Oil: A Big Investment With Big Tax Breaks

    Oil and gas investments can provide unmatched deduction potential for accredited investors.
  3. Investing

    A Natural Gas Primer

    Learn why natural gas is playing a larger role in the energy industry.
  4. Investing

    5 Biggest Risks Faced By Oil And Gas Companies

    Investors 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.
  5. Investing

    5 Biggest Risks Faced By Oil And Gas Companies

    Before investing in gas and oil stocks, consider such factors as political and geological risks.
  6. Investing

    Mine For Profits With Natural Resource Sector Funds

    These funds allow everyday investors to get in on the action in this promising sector.
  7. Financial Advisor

    A Key Tip for Making Your Nest Egg Last Longer

    Retirees who don't want to deplete their nest eggs during a bear market should make sure to do the following.
  8. Investing

    5 Reasons Why Private Equity Investors Like Oil and Gas Companies

    Oil 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.
  9. Investing

    How Oil Prices Impact the U.S. Economy

    Now 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.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center