Publication 225 |
2000 Tax Year |
Depletion
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.
Who Can Claim Depletion
If you have an economic interest in mineral property or standing
timber, 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 a legal interest in mineral
deposits or standing timber.
- You have the 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.
The term "mineral property" means each separate interest you
own in each mineral deposit in each separate tract or parcel of land.
You can treat mineral properties separately or as a group. See section
614 of the Internal Revenue Code for rules on how to treat separate
properties.
The term "timber property" means your economic interest in
standing timber in each tract or block representing a separate timber
account.
Figuring Depletion
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.
Cost Depletion
To figure cost depletion you must first determine the following.
- The property's basis for depletion.
- The total recoverable units in the property's natural
deposit.
- The number of units sold during the tax year.
You must estimate or determine recoverable units (tons, barrels,
board feet, or other measure) using the current industry method and
the most accurate and reliable information you can obtain.
Basis for depletion and recoverable units are explained in chapter 10 of Publication 535.
Number of units sold.
The number of units sold during the tax year is one of the
following.
- The units sold based on your inventories during the tax
year, if you use the accrual method of accounting.
- The units sold for which you receive payment during the year
(regardless of the year of sale), if you use the cash method of
accounting.
The number of units sold during the tax year does not include any
units on which depletion deductions were allowed or allowable in
earlier years.
Figuring the cost depletion deduction.
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.
Step |
Action |
Result |
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. |
Cost depletion on ground water of Ogallala Formation.
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 is 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.
For tax years ending before December 13, 1982, those extracting
ground water for irrigation farming from areas in the Ogallala
Formation outside the Southern High Plains were not required to reduce
their basis in ground water by any allowable cost depletion not
claimed.
Timber depletion.
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
exploration.
To figure timber depletion, you multiply the number of units of
standing timber cut by your depletion unit.
Timber units.
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.
Depletion units.
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 units
acquired during the year and any additions to capital.
- Figure the number of units to take into account by adding
the units acquired during the year to the units on hand in the account
at the beginning of the year and then adding (or subtracting) any
correction to the estimate of the units remaining in the
account.
- Divide the result of (2) by the result of (3). This is your
depletion unit.
When to claim timber depletion.
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 10.
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.
Form T.
Attach Form T to your income tax return if you are claiming a
deduction for timber depletion or electing to treat the cutting of
timber as a sale or exchange.
Example.
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 x 300,000). His
deduction for depletion is $2,160 (27,000 x $.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 for this year and he would
have included the balance of $560 (7,000 x $.08) in the closing
inventory for the year.
Percentage Depletion
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 10 of Publication 535
for a list of the percentages.
Taxable income limit.
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. For tax years
beginning after 1997 and before 2002, this taxable income limit does
not apply to percentage depletion on the marginal production of oil or
natural gas. For information on marginal production, see section
613A(c)(6) of the Internal Revenue Code.
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 property. See
section 1.613-5(b)(1) of the regulations for information on how
to figure the ordinary gain allocable to the property.
More Information
For more information on depletion, see chapter 10 in Publication 535.
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