Depletion is the using up of natural resources by mining, quarrying, drilling, or felling. The depletion deduction allows an owner or operator to account for the reduction of a product's reserves.taxmap/pubs/p225-034.htm#en_us_publink100079316
If you have an economic interest in mineral property or standing timber (defined below), you can take a deduction for depletion. More than one person can have an economic interest in the same mineral deposit or timber.
You have an economic interest if both the following apply.
- You have acquired by investment any interest in mineral deposits or standing timber.
- You have a legal right to income from the extraction of the mineral or the cutting of the timber, to which you must look for a return of your capital investment.
A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. A production payment carved out of, or retained on the sale of, mineral property is not an economic interest.
Mineral property is each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests.
Timber property is your economic interest in standing timber in each tract or block representing a separate timber account.taxmap/pubs/p225-034.htm#en_us_publink100079317
There are two ways of figuring depletion.
- Cost depletion.
- 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.
To figure cost depletion you must first determine the following.
- The property's basis for depletion.
- The total recoverable units of mineral in the property's natural deposit.
- The number of units of mineral sold during the tax year.
You must estimate or determine recoverable units (tons, barrels, board feet, thousands of cubic feet, or other measure) using the current industry method and the most accurate and reliable information you can obtain.
Basis for depletion and total recoverable units are explained in chapter 9 of taxmap/pubs/p225-034.htm#en_us_publink100079319
You determine the number of units sold during the tax year based on your method of accounting. Use the following table to make this determination.
|IF you use ...||THEN the units sold during the year are ...|
|The cash method of accounting||The units sold for which you receive payment during the tax year (regardless of the year of sale).|
|An accrual method of accounting||The units sold based on your inventories.|
The number of units sold during the tax year does not include any units for which depletion deductions were allowed or allowable in earlier years. taxmap/pubs/p225-034.htm#en_us_publink100079320
Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by taking the following steps.
| 1||Divide your property's basis for depletion by total recoverable units.||Rate per unit.|
| 2||Multiply the rate per unit by units sold during the tax year.||Cost depletion deduction.|
Farmers who extract ground water from the Ogallala Formation for irrigation are allowed cost depletion. Cost depletion is allowed when it can be demonstrated the ground water is being depleted and the rate of recharge is so low that, once extracted, the water would be lost to the taxpayer and immediately succeeding generations. To figure your cost depletion deduction, use the guidance provided in Revenue Procedure 66-11 in Cumulative Bulletin 1966-1.taxmap/pubs/p225-034.htm#en_us_publink100079322
Depletion takes place when you cut standing timber (including Christmas trees). You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation.taxmap/pubs/p225-034.htm#en_us_publink100079323
To figure your cost depletion allowance, multiply the number of units of standing timber cut by your depletion unit.taxmap/pubs/p225-034.htm#en_us_publink100079324
When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. You measure the timber using board feet, log scale, cords, or other units. If you later determine that you have more or less units of timber, you must adjust the original estimate.taxmap/pubs/p225-034.htm#en_us_publink100079325
You figure your depletion unit each year by taking the following steps.
- Determine your cost or the adjusted basis of the timber on hand at the beginning of the year.
- Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital.
- Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account.
- Divide the result of (2) by the result of (3). This is your depletion unit.
Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you elect to treat the cutting of timber as a sale or exchange as explained in chapter 8. Include allowable depletion for timber products not sold during the tax year the timber is cut, as a cost item in the closing inventory of timber products for the year. The inventory is your basis for determining gain or loss in the tax year you sell the timber products. taxmap/pubs/p225-034.htm#en_us_publink100079327
Complete and attach Form T to your income tax return if you are claiming a deduction for timber depletion, electing to treat the cutting of timber as a sale or exchange, or making an outright sale of timber. See the Instructions for Form T (Timber).taxmap/pubs/p225-034.htm#en_us_publink100079328
Sam Brown bought a farm that included standing timber. This year Sam determined that the standing timber could produce 300,000 units when cut. At that time, the adjusted basis of the standing timber was $24,000. Sam then cut and sold 27,000 units. (Sam did not elect to treat the cutting of the timber as a sale or exchange.) Sam's depletion for each unit for the year is $.08 ($24,000 ÷ 300,000). His deduction for depletion is $2,160 (27,000 × $.08). If Sam had cut 27,000 units but sold only 20,000 units during the year, his depletion for each unit would have remained at $.08. However, his depletion deduction would have been $1,600 (20,000 × $.08) for this year and he would have included the balance of $560 (7,000 × $.08) in the closing inventory for the year.taxmap/pubs/p225-034.htm#en_us_publink100079329
You can use percentage depletion on certain mines, wells, and other natural deposits. You cannot use the percentage method to figure depletion for standing timber, soil, sod, dirt, or turf.
To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the year. See Mines and other natural deposits in chapter 9 of Publication 535 for a list of the percentages. You can find a complete list in section 613(b) of the Internal Revenue Code.taxmap/pubs/p225-034.htm#en_us_publink100079330
The percentage depletion deduction cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction and the domestic production activities deduction.
The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit.
- Do not deduct any net operating loss deduction from the gross income from the property.
- Corporations do not deduct charitable contributions from the gross income from the property.
- If, during the year, you disposed of an item of section 1245 property used in connection with the mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. See section 1.613-5(b)(1) of the regulations for information on how to figure the ordinary gain allocable to the property.
For more information on depletion, see chapter 9 in Publication 535.