Tax Deduction: Percentage Depletion versus Cost 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. There are two ways of figuring depletion: 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.  Cost depletion is computed on the basis of initial capitalization costs. Over the life of the well, a portion of these costs can be recovered each year based on the percentage of the production for the year as compared to the estimated recoverable oil and gas reserves at the beginning of the year. Percentage depletion is computed on the basis of the income from the property rather than capitalization costs. The tax shelter provided by percentage depletion may result in a larger deduction than cost depletion. Percentage depletion allows a tax deduction equal to 15% of the gross revenue from and oil or gas producing property. If you have questions regarding depletion or related issues click here to contact Paul.

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