15.7 Depletion
Key Takeaways
Depletion = cost recovery for natural resources (oil, gas, minerals, timber).
Cost depletion: (Basis / Total Units) × Units Sold.
Percentage depletion: Statutory % of gross income (15% oil/gas).
Percentage depletion can continue after basis reaches zero.
Percentage depletion limited to 50% of property income (100% oil/gas).
Only independent producers can use percentage depletion for oil/gas.
Why This Matters for the Exam
Depletion rules are unique. Know the two methods and the ability to continue after basis is zero.
Two Methods of Depletion
| Method | Basis |
|---|---|
| Cost Depletion | Units-of-production (like depreciation) |
| Percentage Depletion | % of gross income |
| Use: | Greater of the two each year |
Cost Depletion Formula
| Step | Calculation |
|---|---|
| 1 | Adjusted Basis / Total Estimated Units |
| 2 | Rate × Units SOLD (not extracted) |
| Stops when | Basis reaches zero |
Percentage Depletion Rates
| Resource | Rate |
|---|---|
| Oil and Gas | 15% |
| Gold, Silver, Copper | 15% |
| Coal, Lignite | 10% |
| Gravel, Sand, Stone | 5% |
Key Advantage of Percentage Depletion
| Feature | Cost Depletion | Percentage Depletion |
|---|---|---|
| Stops at zero basis? | Yes | NO |
| Can exceed basis? | No | YES |
| Unique benefit | Unlimited recovery |
Income Limitations
| Property Type | Limit |
|---|---|
| Most minerals | 50% of property taxable income |
| Oil and Gas | 100% of property taxable income |
| Overall (oil/gas) | 65% of taxpayer's total taxable income |
Who Can Use Percentage Depletion?
| Taxpayer | Oil/Gas | Other Minerals |
|---|---|---|
| Independent producers | Yes | Yes |
| Royalty owners | Yes | Yes |
| Integrated oil companies | NO | Yes |
Real-World Scenario
Scenario: Oil well, $50,000 basis, $400,000 gross income, $120,000 taxable income.
- Cost depletion: $8,000 (engineers' estimate).
- Percentage depletion: $400,000 × 15% = $60,000.
- 100% income limit: $120,000 (oil/gas limit).
- Allowed: $60,000 (greater than cost).
- Basis: Reduced to $0 in future years but percentage continues.
On the Exam
Question types to practice on depletion:
- Method Questions: "Which method continues after zero basis?"
- Rate Questions: "What is the percentage depletion rate for oil?"
- Limit Questions: "What is the oil/gas income limit?"
The key is to remember: Cost = stops at zero basis. Percentage = continues (unique). Oil/gas 15%, limited to 100% of property income. Independent producers only for oil/gas percentage.
Which method allows deductions after basis reaches zero?
Cost Depletion
Percentage Depletion
MACRS Depletion
Amortized Depletion
Coal mine: $100,000 basis, 50,000 tons estimated. 5,000 tons SOLD. Cost depletion?
$10,000
$20,000
$50,000
$100,000
Oil/gas percentage depletion limited to what % of property taxable income?
15%
50%
65%
100%
Sections you finish are checked off in the contents.