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Depletion is an
accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to compare with other ob ...
and
tax A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity In law Law is a system A system is a group of Interaction, interacting or interrelated elements that act accord ...
concept used most often in the
mining Mining is the extraction of valuable mineral In geology and mineralogy, a mineral or mineral species is, broadly speaking, a solid chemical compound with a fairly well-defined chemical composition and a specific crystal structure that occu ...

mining
,
timber Lumber, also known as timber, is wood Wood is a porous and fibrous structural tissue found in the stems and roots of tree In botany, a tree is a perennial plant with an elongated Plant stem, stem, or trunk (botany), trunk, sup ...

timber
, and
petroleum Petroleum, also known as crude oil and oil, is a naturally occurring, yellowish-black liquid A liquid is a nearly incompressible In fluid mechanics or more generally continuum mechanics, incompressible flow (isochoric process, isoc ...

petroleum
industries. It is similar to
depreciation In accountancy Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been ...

depreciation
in that it is a cost recovery system for accounting and tax reporting: "The depletion deduction" allows an owner or operator to account for the reduction of a product's reserves.


Types of depletion

For tax purposes, the two types of depletion are percentage depletion and cost depletion. For mineral property, the method leading to the largest deduction is generally used. For standing timber, use of the cost depletion method is required.Publication 535 (2007), Business Expenses
/ref> Depletion, for both accounting purposes and United States tax purposes, is a method of recording the gradual expense or use of
natural resource Natural resources are resource Resource refers to all the materials available in our environment which help us to satisfy our needs and wants. Resources can broadly be classified upon their availability — they are classified into renewabl ...
s over time. Depletion is the using up of natural resources by
mining Mining is the extraction of valuable mineral In geology and mineralogy, a mineral or mineral species is, broadly speaking, a solid chemical compound with a fairly well-defined chemical composition and a specific crystal structure that occu ...

mining
,
quarrying Stone quarry in Soignies, Hainaut (province), Belgium">Hainaut_(province).html" ;"title="Soignies, Hainaut (province)">Soignies, Hainaut (province), Belgium A quarry is a type of open-pit mine File:Ende Gelände 2017 CHB 23 (cropped).j ...
,
drilling Drilling is a cutting Cutting is the separation or opening of a physical object, into two or more portions, through the application of an acutely directed force In physics Physics (from grc, φυσική (ἐπιστήμη), p ...
, or
felling Felling is the process of cutting down trees,"Feller" def. 2. and "Felling", def. 1. ''Oxford English Dictionary'' Second Edition on CD-ROM (v. 4.0) © Oxford University Press 2009 an element of the task of logging Logging is the process of cut ...

felling
. According to the
IRS The Internal Revenue Service (IRS) is the revenue service A revenue service, revenue agency or taxation authority is a government agency responsible for the intake of government revenue, including taxes and sometimes non-tax revenue. ...

IRS
Newswire,IRS Issues Guidance on Recoverable Reserves
/ref> over 50 percent of oil and gas extraction businesses use cost depletion to figure their depletion deduction. Mineral property includes oil and gas wells, mines, and other natural resource deposits (including geothermal deposits). For that purpose, property is each separate interest businesses own in each
mineral deposit ore – psilomelane (size: 6.7 × 5.8 × 5.1 cm) ore – galena and anglesite (size: 4.8 × 4.0 × 3.0 cm) ore (size: 7.5 × 6.1 × 4.1 cm) File:OreCartPachuca.JPG, upMinecart on display at the Historic Archive and Museum of Min ...
in each separate tract or parcel of land. Businesses can treat two or more separate interests as one property or as separate properties.


Percentage depletion

To figure percentage depletion, a certain percentage, specified for each mineral, is multiplied by gross income from the property during the tax year. The rates to be used and other conditions and qualifications for oil and gas wells are discussed below under ''Independent Producers and Royalty Owners'' and under ''Natural Gas Wells''. Rates and other rules for percentage depletion of other specific minerals are found later in ''Mines and Geothermal Deposits''.


Cost depletion

Cost depletion is an accounting method by which costs of natural resources are allocated to depletion over the period that make up the life of the asset. Cost depletion is computed by estimating the total quantity of mineral or other resources acquired and assigning a proportionate amount of the total resource cost to the quantity extracted in the period. For example, assume Big Texas Oil, Co. had discovered a large reserve of oil and estimates that the oil well will produce 200,000 barrels of oil. If the company invests $100,000 to extract the oil and extracts 10,000 barrels the first year, the depletion deduction is $5,000 ($100,000 X 10,000/200,000). Cost depletion for tax purposes may be completely different from cost depletion for accounting purposes: :CD = S/(R+S) \times AB = AB/(R+S) \times S :CD = Cost Depletion. :S = Units sold in the current year :R = Reserves on hand at the end of the current year :AB = Adjusted basis of the property at the end of the current year


Accounting

Adjusted basis is the basis at end of year adjusted for prior years depletion in cost or percentage. It automatically allows for adjustments to the basis during the taxable year. By using the units remaining at the end of the year, the adjustment allows for revised estimates of the reserves. Depletion is based upon sales and not production. Units are considered sold in the year the proceeds are taxable under the taxpayer's accounting method.


Reserves

Reserves generally include proven developed reserves and "probable" or "prospective" reserves if there is reasonable evidence to have believed that such quantities existed at that time.


Example

If producer X has capitalized costs on property A of $40,000, originally consisting of the lease bonus, capitalized exploration costs, and some capitalized carrying costs, and the lease has been producing for several years and during this time, X has claimed $10,000 of allowable depletion. In 2009, X's share of production sold was 40,000 barrels and an engineer's report indicated that 160,000 barrels could be recovered after December 31, 2009. The calculation of cost depletion for this lease would be as follows: :Cost depletion = S/(R+S) × AB or AB/(R+S) × S :CD = 40,000/(40,000 + 160,000) × ($40,000 − $10,000) : = 40,000/200,000 × $30,000 : = $6,000


See also

*
Depreciation In accountancy Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporations. Accounting, which has been ...

Depreciation
*
Amortization Amortization (or amortisation; ) is paying off an amount owed over time by making planned, incremental payments of principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academi ...
* Oil depletion allowance


References

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Further reading

* Shulman, Peter A., “The Making of a Tax Break: The Oil Depletion Allowance, Scientific Taxation, and Natural Resources Policy in the Early Twentieth Century,” ''Journal of Policy History'' (2011), 23#3 pp 281–322. Corporate taxation Asset Expense