what is depletion

I'm not an expert on this. But as I recall it is an alternative to depreciation. For oil companies they get to deduct a percentage of the value of the oil they get. It is unrelated to actual cost, and they get to keep taking it even after all their costs have been deducted. I am not aware that it is ever recaptured.

Depletion is similar to depreciation in that it is an accounting device designed to match the recovery of the cost of an asset (depletable natural resources) with the income the asset produces over the asset's useful life or existence.

Cost depletion is based on units of production and is limited to the total cost of the resource. So I can write off the cost of the resource as I recover and sell it.

Percentage depletion is one of those tax gimmicks allowed to the oil and gas industry (and somewhat less generously to producers of minerals, etc.) that were the subject of the Congressional hearings yesterday. Instead of recovering a fixed cost as the resource is depleted, the taxpayer is allowed to claim a statutory percentage of the gross income from the property. Oil and gas gets a depletion deduction of 22% of gross income, as long as the property continues to produce income. The total deductions over the life of the property are not limited to the taxpayer's cost. There are limitations, however, on how much percentage depletion can be deducted each year.

Here is a link to a site that provides examples calculating cost and percentage depletion:

Katie in San Diego

It is similar. Instead of expensing "use", it is expensing the removal value of minerals (or oil or timber) from the land itself.

Just for educational purposes, let me ask: If I (as an individual) buy a small rental property, or a computer to use in consulting work, I'm able to depreciate over time more or less the amount I paid for that asset -- but not more.

But suppose a big oil or mining company buys a piece of property, or the oil or mineral rights in a piece of property for a certain amount, and begins drilling or digging, with substantial success in this endeavor. As times goes on, I'm guessing that over and above deductible operating expenses, they can take depletion expenses or deductions for vastly more than they actually paid for the property or the rights. Is that a fair assumption?

Yes. The amount deductible as percentage depletion, where that is allowed, is not limited to the cost of the property or the drilling/ mining rights. Also, the depletion allowance is based on the sales revenue from the product, which is unrelated to its cost. For example, if you bought drilling rights to an O&G property when oil was selling for $20 a barrel, and you sell (just for round numbers) 1,000 barrels a year, your depletion deduction for Year 1 would be $4,400 (22% of $20,000 sales revenue.) But in a later year when oil sells for $100 a barrel, your depletion deduction would be $22,000 (22% of $100,000). Of course your deduction might be otherwise limited; for example, the deduction is limited to 50% of the net income from the property.

Katie in San Diego

Note that in that example, what was "bought" by the miner was the RIGHT to extract, and not title to the land itself. Rent paid for mining rights is excluded from the net income computation. In some places, it is possible to buy mining rights without title to the land [surface] itself.

So do oil companies deduct their drilling costs (labor, depreciation of equipment) as well as take this depletion deduction? And if they get to deduct drilling costs do they incorporate it into the cost of goods sold or as a current expense?

Why do you say "my example"? Did you define the scenario elsewhere.

It sounds like you're saying that an oil producer cannot deduct rent, but must take depletion instead. Is that so? However, the person receiving rent, would they report income on their Schedule E?

Finally, I notice that depletion occurs on the AMT form 6251. This is strange for two reasons. First, it is strange for a person running an oil business to use Schedule C (one would imagine they run a corporation), but I suppose if they get a K-1 from an LLC then it might matter. Second, does the personal AMT tax (form 6251) or corporate AMT limit the depletion deduction.

100% taxable income limitation on percentage depletion on the marginal production of oil and natural gas also applies to tax years beginning in 2010 and 2011.

but major integrated oil companies MUST take cost depletion and it cannot exceed cost. Royalty owners can take 15% depletion.

It's not your example. Read the tread, and an example was inserted in another reply.

Rent is not deductible for computing net income subject to depletion. Rent is deductible for computing net income subject to tax.

Limit? No. However, depletion for AMTI may be different than for the regular tax.

and you won't see it in the 22% section). But if you keep reading, 613A does contain 22%.

> and you won't see it in the 22% section).>

I suppose only Katie can say why she chose to use 22% in her example. The rate has been 15% for marginal wells since 2001. See

for a table of rates (depletion percentage) since 1991.

On 5/13/2011 3:44 PM, AES wrote: ...

True, but...it's not unlimited.

As of the last time I looked (sometime within the last couple of years, but not just within the last few months) at the information in the local area royalty owners' annual meeting packet, the following was given--I don't think it's changed much--yet. Hmmmm.....looking at the footnotes, I guess this must have been the 2009 meeting.

Now granted, the following was prepared as a response to the current administration's having floated the trial balloon of reducing or eliminating the depletion allowance but it I think outlines at least part of the impact on US production if it were to be eliminated.

I'll note that while there is activity again in the oil patch around here owing to the current market prices, even in the period when prices fell back earlier from previous peaks it was clearly obvious that activity was scaled back nearly immediately by quite significant amounts. These small operators would really back off if the depletion allowance were also to go away unless market prices remained very high; probably far higher than we would like to see as consumers.