Tax depletion
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[edit] Description
Depeletion, for United States (IRS) tax purposes, (and accounting purposes) is a method of recording the gradual expense or use of resources over time. Depletion is the using up of natural resources by mining, quarrying, drilling, or felling.
Tax depletion is used most often in mining, timber, petroluem, or other similar industries. The depletion deduction allows an owner or operator to account for the reduction of a product's reserves. Depletion is similar to depreciation in that, it is a cost recovery system for accounting and tax reporting. For tax purposes, there are two types of depeletion; cost depletion and percentage depletion
For mineral property, you generally must use the method that gives you the larger deduction. For standing timber, you must use cost depletion. [1]
According to the IRS Newswire[2], over 50 percent of oil and gas extraction businesses use cost depletion to figure their depletion deduction.
Mineral property includes oil and gas wells, mines, and other natural deposits (including geothermal deposits). For this purpose, the term “property” means each separate interest businesses own in each mineral deposit in each separate tract or parcel of land. Businesses can treat two or more separate interests as one property or as separate properties.
[edit] Types of depletion
* Percentage depletion-To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year. The rates to be used and other conditions and qualifications for oil and gas wells are discussed later under Independent Producers and Royalty Owners and under Natural Gas Wells. Rates and other rules for percentage depletion of other specific minerals are found later in Mines and Geothermal Deposits[3].
* Cost depletion
Cost depletion is an accounting method by which costs of natural resources are allocated to depletion over the period that make up the life of the asset. Cost depletion is computed by (1) estimating the total quantity of mineral or other resources acquired and (2) assigning a proportionate amount of the total resource cost to the quantity extracted in the period.
For example, Big Texas Oil, Co. discovers a large reserve of oil. The company has estimated the oil well will produce 200,000 barrels of oil. The company invests $100,000 dollars the to extract the oil, and they extract 10,000 barrels the first year. Therefore, the depletion deduction is $5,000 ($100,000 X 10,000/200,000).
[edit] See also
- Sustainability depletion
- Depreciation
