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Www. Www.irs.gov1040x irs. Www.irs.gov1040x gov1040x 9. Www.irs.gov1040x   Depletion Table of Contents Introduction Topics - This chapter discusses: Who Can Claim Depletion? Mineral PropertyCost Depletion Percentage Depletion Oil and Gas Wells Mines and Geothermal Deposits Lessor's Gross Income TimberTimber units. Www.irs.gov1040x Depletion unit. Www.irs.gov1040x Introduction Depletion is the using up of natural resources by mining, drilling, quarrying stone, or cutting timber. Www.irs.gov1040x The depletion deduction allows an owner or operator to account for the reduction of a product's reserves. Www.irs.gov1040x There are two ways of figuring depletion: cost depletion and percentage depletion. Www.irs.gov1040x For mineral property, you generally must use the method that gives you the larger deduction. Www.irs.gov1040x For standing timber, you must use cost depletion. Www.irs.gov1040x Topics - This chapter discusses: Who can claim depletion Mineral property Timber Who Can Claim Depletion? If you have an economic interest in mineral property or standing timber, you can take a deduction for depletion. Www.irs.gov1040x More than one person can have an economic interest in the same mineral deposit or timber. Www.irs.gov1040x In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Www.irs.gov1040x You have an economic interest if both the following apply. Www.irs.gov1040x You have acquired by investment any interest in mineral deposits or standing timber. Www.irs.gov1040x You have a legal right to income from the extraction of the mineral or cutting of the timber to which you must look for a return of your capital investment. Www.irs.gov1040x 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. Www.irs.gov1040x A production payment carved out of, or retained on the sale of, mineral property is not an economic interest. Www.irs.gov1040x Individuals, corporations, estates, and trusts who claim depletion deductions may be liable for alternative minimum tax. Www.irs.gov1040x Basis adjustment for depletion. Www.irs.gov1040x   You must reduce the basis of your property by the depletion allowed or allowable, whichever is greater. Www.irs.gov1040x Mineral Property Mineral property includes oil and gas wells, mines, and other natural deposits (including geothermal deposits). Www.irs.gov1040x For this purpose, the term “property” means each separate interest you own in each mineral deposit in each separate tract or parcel of land. Www.irs.gov1040x You can treat two or more separate interests as one property or as separate properties. Www.irs.gov1040x See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests. Www.irs.gov1040x There are two ways of figuring depletion on mineral property. Www.irs.gov1040x Cost depletion. Www.irs.gov1040x Percentage depletion. Www.irs.gov1040x Generally, you must use the method that gives you the larger deduction. Www.irs.gov1040x However, unless you are an independent producer or royalty owner, you generally cannot use percentage depletion for oil and gas wells. Www.irs.gov1040x See Oil and Gas Wells , later. Www.irs.gov1040x Cost Depletion To figure cost depletion you must first determine the following. Www.irs.gov1040x The property's basis for depletion. Www.irs.gov1040x The total recoverable units of mineral in the property's natural deposit. Www.irs.gov1040x The number of units of mineral sold during the tax year. Www.irs.gov1040x Basis for depletion. Www.irs.gov1040x   To figure the property's basis for depletion, subtract all the following from the property's adjusted basis. Www.irs.gov1040x Amounts recoverable through: Depreciation deductions, Deferred expenses (including deferred exploration and development costs), and Deductions other than depletion. Www.irs.gov1040x The residual value of land and improvements at the end of operations. Www.irs.gov1040x The cost or value of land acquired for purposes other than mineral production. Www.irs.gov1040x Adjusted basis. Www.irs.gov1040x   The adjusted basis of your property is your original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Www.irs.gov1040x Your adjusted basis can never be less than zero. Www.irs.gov1040x See Publication 551, Basis of Assets, for more information on adjusted basis. Www.irs.gov1040x Total recoverable units. Www.irs.gov1040x   The total recoverable units is the sum of the following. Www.irs.gov1040x The number of units of mineral remaining at the end of the year (including units recovered but not sold). Www.irs.gov1040x The number of units of mineral sold during the tax year (determined under your method of accounting, as explained next). Www.irs.gov1040x   You must estimate or determine recoverable units (tons, pounds, ounces, barrels, thousands of cubic feet, or other measure) of mineral products using the current industry method and the most accurate and reliable information you can obtain. Www.irs.gov1040x You must include ores and minerals that are developed, in sight, blocked out, or assured. Www.irs.gov1040x You must also include probable or prospective ores or minerals that are believed to exist based on good evidence. Www.irs.gov1040x But see Elective safe harbor for owners of oil and gas property , later. Www.irs.gov1040x Number of units sold. Www.irs.gov1040x   You determine the number of units sold during the tax year based on your method of accounting. Www.irs.gov1040x Use the following table to make this determination. Www.irs.gov1040x    IF you  use . Www.irs.gov1040x . Www.irs.gov1040x . Www.irs.gov1040x THEN the units sold during the year are . Www.irs.gov1040x . Www.irs.gov1040x . Www.irs.gov1040x The cash method of accounting The units sold for which you receive payment during the tax year (regardless of the year of sale). Www.irs.gov1040x An accrual method of accounting The units sold based on your inventories and method of accounting for inventory. Www.irs.gov1040x   The number of units sold during the tax year does not include any for which depletion deductions were allowed or allowable in earlier years. Www.irs.gov1040x Figuring the cost depletion deduction. Www.irs.gov1040x   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. Www.irs.gov1040x Step Action Result 1 Divide your property's basis for depletion by total recoverable units. Www.irs.gov1040x Rate per unit. Www.irs.gov1040x 2 Multiply the rate per unit by units sold during the tax year. Www.irs.gov1040x Cost depletion deduction. Www.irs.gov1040x You must keep accounts for the depletion of each property and adjust these accounts each year for units sold and depletion claimed. Www.irs.gov1040x Elective safe harbor for owners of oil and gas property. Www.irs.gov1040x   Instead of using the method described earlier to determine the total recoverable units, you can use an elective safe harbor. Www.irs.gov1040x If you choose the elective safe harbor, the total recoverable units equal 105% of a property's proven reserves (both developed and undeveloped). Www.irs.gov1040x For details, see Revenue Procedure 2004-19 on page 563 of Internal Revenue Bulletin 2004-10, available at www. Www.irs.gov1040x irs. Www.irs.gov1040x gov/pub/irs-irbs/irb04-10. Www.irs.gov1040x pdf. Www.irs.gov1040x   To make the election, attach a statement to your timely filed (including extensions) original return for the first tax year for which the safe harbor is elected. Www.irs.gov1040x The statement must indicate that you are electing the safe harbor provided by Revenue Procedure 2004-19. Www.irs.gov1040x The election, if made, is effective for the tax year in which it is made and all later years. Www.irs.gov1040x It cannot be revoked for the tax year in which it is elected, but may be revoked in a later year. Www.irs.gov1040x Once revoked, it cannot be re-elected for the next 5 years. Www.irs.gov1040x Percentage Depletion To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year. Www.irs.gov1040x The rates to be used and other rules for oil and gas wells are discussed later under Independent Producers and Royalty Owners and under Natural Gas Wells . Www.irs.gov1040x Rates and other rules for percentage depletion of other specific minerals are found later in Mines and Geothermal Deposits . Www.irs.gov1040x Gross income. Www.irs.gov1040x   When figuring percentage depletion, subtract from your gross income from the property the following amounts. Www.irs.gov1040x Any rents or royalties you paid or incurred for the property. Www.irs.gov1040x The part of any bonus you paid for a lease on the property allocable to the product sold (or that otherwise gives rise to gross income) for the tax year. Www.irs.gov1040x A bonus payment includes amounts you paid as a lessee to satisfy a production payment retained by the lessor. Www.irs.gov1040x   Use the following fraction to figure the part of the bonus you must subtract. Www.irs.gov1040x No. Www.irs.gov1040x of units sold in the tax year Recoverable units from the property × Bonus Payments For oil and gas wells and geothermal deposits, more information about the definition of gross income from the property is under Oil and Gas Wells , later. Www.irs.gov1040x For other property, more information about the definition of gross income from the property is under Mines and Geothermal Deposits , later. Www.irs.gov1040x Taxable income limit. Www.irs.gov1040x   The percentage depletion deduction generally 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. Www.irs.gov1040x   Taxable income from the property means gross income from the property minus all allowable deductions (except any deduction for depletion or domestic production activities) attributable to mining processes, including mining transportation. Www.irs.gov1040x These deductible items include, but are not limited to, the following. Www.irs.gov1040x Operating expenses. Www.irs.gov1040x Certain selling expenses. Www.irs.gov1040x Administrative and financial overhead. Www.irs.gov1040x Depreciation. Www.irs.gov1040x Intangible drilling and development costs. Www.irs.gov1040x Exploration and development expenditures. Www.irs.gov1040x Deductible taxes (see chapter 5), but not taxes that you capitalize or take as a credit. Www.irs.gov1040x Losses sustained. Www.irs.gov1040x   The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit. Www.irs.gov1040x Do not deduct any net operating loss deduction from the gross income from the property. Www.irs.gov1040x Corporations do not deduct charitable contributions from the gross income from the property. Www.irs.gov1040x If, during the year, you dispose of an item of section 1245 property that was used in connection with 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. Www.irs.gov1040x See section 1. Www.irs.gov1040x 613-5(b)(1) of the regulations for information on how to figure the ordinary gain allocable to the property. Www.irs.gov1040x Oil and Gas Wells You cannot claim percentage depletion for an oil or gas well unless at least one of the following applies. Www.irs.gov1040x You are either an independent producer or a royalty owner. Www.irs.gov1040x The well produces natural gas that is either sold under a fixed contract or produced from geopressured brine. Www.irs.gov1040x If you are an independent producer or royalty owner, see Independent Producers and Royalty Owners , next. Www.irs.gov1040x For information on the depletion deduction for wells that produce natural gas that is either sold under a fixed contract or produced from geopressured brine, see Natural Gas Wells , later. Www.irs.gov1040x Independent Producers and Royalty Owners If you are an independent producer or royalty owner, you figure percentage depletion using a rate of 15% of the gross income from the property based on your average daily production of domestic crude oil or domestic natural gas up to your depletable oil or natural gas quantity. Www.irs.gov1040x However, certain refiners, as explained next, and certain retailers and transferees of proven oil and gas properties, as explained next, cannot claim percentage depletion. Www.irs.gov1040x For information on figuring the deduction, see Figuring percentage depletion , later. Www.irs.gov1040x Refiners who cannot claim percentage depletion. Www.irs.gov1040x   You cannot claim percentage depletion if you or a related person refine crude oil and you and the related person refined more than 75,000 barrels on any day during the tax year based on average (rather than actual) daily refinery runs for the tax year. Www.irs.gov1040x The average daily refinery run is computed by dividing total refinery runs for the tax year by the total number of days in the tax year. Www.irs.gov1040x Related person. Www.irs.gov1040x   You and another person are related persons if either of you holds a significant ownership interest in the other person or if a third person holds a significant ownership interest in both of you. Www.irs.gov1040x For example, a corporation, partnership, estate, or trust and anyone who holds a significant ownership interest in it are related persons. Www.irs.gov1040x A partnership and a trust are related persons if one person holds a significant ownership interest in each of them. Www.irs.gov1040x For purposes of the related person rules, significant ownership interest means direct or indirect ownership of 5% or more in any one of the following. Www.irs.gov1040x The value of the outstanding stock of a corporation. Www.irs.gov1040x The interest in the profits or capital of a partnership. Www.irs.gov1040x The beneficial interests in an estate or trust. Www.irs.gov1040x Any interest owned by or for a corporation, partnership, trust, or estate is considered to be owned directly both by itself and proportionately by its shareholders, partners, or beneficiaries. Www.irs.gov1040x Retailers who cannot claim percentage depletion. Www.irs.gov1040x   You cannot claim percentage depletion if both the following apply. Www.irs.gov1040x You sell oil or natural gas or their by-products directly or through a related person in any of the following situations. Www.irs.gov1040x Through a retail outlet operated by you or a related person. Www.irs.gov1040x To any person who is required under an agreement with you or a related person to use a trademark, trade name, or service mark or name owned by you or a related person in marketing or distributing oil, natural gas, or their by-products. Www.irs.gov1040x To any person given authority under an agreement with you or a related person to occupy any retail outlet owned, leased, or controlled by you or a related person. Www.irs.gov1040x The combined gross receipts from sales (not counting resales) of oil, natural gas, or their by-products by all retail outlets taken into account in (1) are more than $5 million for the tax year. Www.irs.gov1040x   For the purpose of determining if this rule applies, do not count the following. Www.irs.gov1040x Bulk sales (sales in very large quantities) of oil or natural gas to commercial or industrial users. Www.irs.gov1040x Bulk sales of aviation fuels to the Department of Defense. Www.irs.gov1040x Sales of oil or natural gas or their by-products outside the United States if none of your domestic production or that of a related person is exported during the tax year or the prior tax year. Www.irs.gov1040x Related person. Www.irs.gov1040x   To determine if you and another person are related persons, see Related person under Refiners who cannot claim percentage depletion, earlier. Www.irs.gov1040x Sales through a related person. Www.irs.gov1040x   You are considered to be selling through a related person if any sale by the related person produces gross income from which you may benefit because of your direct or indirect ownership interest in the person. Www.irs.gov1040x   You are not considered to be selling through a related person who is a retailer if all the following apply. Www.irs.gov1040x You do not have a significant ownership interest in the retailer. Www.irs.gov1040x You sell your production to persons who are not related to either you or the retailer. Www.irs.gov1040x The retailer does not buy oil or natural gas from your customers or persons related to your customers. Www.irs.gov1040x There are no arrangements for the retailer to acquire oil or natural gas you produced for resale or made available for purchase by the retailer. Www.irs.gov1040x Neither you nor the retailer knows of or controls the final disposition of the oil or natural gas you sold or the original source of the petroleum products the retailer acquired for resale. Www.irs.gov1040x Transferees who cannot claim percentage depletion. Www.irs.gov1040x   You cannot claim percentage depletion if you received your interest in a proven oil or gas property by transfer after 1974 and before October 12, 1990. Www.irs.gov1040x For a definition of the term “transfer,” see section 1. Www.irs.gov1040x 613A-7(n) of the regulations. Www.irs.gov1040x For a definition of the term “interest in proven oil or gas property,” see section 1. Www.irs.gov1040x 613A-7(p) of the regulations. Www.irs.gov1040x Figuring percentage depletion. Www.irs.gov1040x   Generally, as an independent producer or royalty owner, you figure your percentage depletion by computing your average daily production of domestic oil or gas and comparing it to your depletable oil or gas quantity. Www.irs.gov1040x If your average daily production does not exceed your depletable oil or gas quantity, you figure your percentage depletion by multiplying the gross income from the oil or gas property (defined later) by 15%. Www.irs.gov1040x If your average daily production of domestic oil or gas exceeds your depletable oil or gas quantity, you must make an allocation as explained later under Average daily production. Www.irs.gov1040x   In addition, there is a limit on the percentage depletion deduction. Www.irs.gov1040x See Taxable income limit , later. Www.irs.gov1040x Average daily production. Www.irs.gov1040x   Figure your average daily production by dividing your total domestic production of oil or gas for the tax year by the number of days in your tax year. Www.irs.gov1040x Partial interest. Www.irs.gov1040x   If you have a partial interest in the production from a property, figure your share of the production by multiplying total production from the property by your percentage of interest in the revenues from the property. Www.irs.gov1040x   You have a partial interest in the production from a property if you have a net profits interest in the property. Www.irs.gov1040x To figure the share of production for your net profits interest, you must first determine your percentage participation (as measured by the net profits) in the gross revenue from the property. Www.irs.gov1040x To figure this percentage, you divide the income you receive for your net profits interest by the gross revenue from the property. Www.irs.gov1040x Then multiply the total production from the property by your percentage participation to figure your share of the production. Www.irs.gov1040x Example. Www.irs.gov1040x Javier Robles owns oil property in which Pablo Olmos owns a 20% net profits interest. Www.irs.gov1040x During the year, the property produced 10,000 barrels of oil, which Javier sold for $200,000. Www.irs.gov1040x Javier had expenses of $90,000 attributable to the property. Www.irs.gov1040x The property generated a net profit of $110,000 ($200,000 − $90,000). Www.irs.gov1040x Pablo received income of $22,000 ($110,000 × . Www.irs.gov1040x 20) for his net profits interest. Www.irs.gov1040x Pablo determined his percentage participation to be 11% by dividing $22,000 (the income he received) by $200,000 (the gross revenue from the property). Www.irs.gov1040x Pablo determined his share of the oil production to be 1,100 barrels (10,000 barrels × 11%). Www.irs.gov1040x Depletable oil or natural gas quantity. Www.irs.gov1040x   Generally, your depletable oil quantity is 1,000 barrels. Www.irs.gov1040x Your depletable natural gas quantity is 6,000 cubic feet multiplied by the number of barrels of your depletable oil quantity that you choose to apply. Www.irs.gov1040x If you claim depletion on both oil and natural gas, you must reduce your depletable oil quantity (1,000 barrels) by the number of barrels you use to figure your depletable natural gas quantity. Www.irs.gov1040x Example. Www.irs.gov1040x You have both oil and natural gas production. Www.irs.gov1040x To figure your depletable natural gas quantity, you choose to apply 360 barrels of your 1000-barrel depletable oil quantity. Www.irs.gov1040x Your depletable natural gas quantity is 2. Www.irs.gov1040x 16 million cubic feet of gas (360 × 6000). Www.irs.gov1040x You must reduce your depletable oil quantity to 640 barrels (1000 − 360). Www.irs.gov1040x If you have production from marginal wells, see section 613A(c)(6) of the Internal Revenue Code to figure your depletable oil or natural gas quantity. Www.irs.gov1040x Also, see Notice 2012-50, available at www. Www.irs.gov1040x irs. Www.irs.gov1040x gov/irb/2012–31_IRB/index. Www.irs.gov1040x html. Www.irs.gov1040x Business entities and family members. Www.irs.gov1040x   You must allocate the depletable oil or gas quantity among the following related persons in proportion to each entity's or family member's production of domestic oil or gas for the year. Www.irs.gov1040x Corporations, trusts, and estates if 50% or more of the beneficial interest is owned by the same or related persons (considering only persons that own at least 5% of the beneficial interest). Www.irs.gov1040x You and your spouse and minor children. Www.irs.gov1040x A related person is anyone mentioned in the related persons discussion under Nondeductible loss in chapter 2 of Publication 544, except that for purposes of this allocation, item (1) in that discussion includes only an individual, his or her spouse, and minor children. Www.irs.gov1040x Controlled group of corporations. Www.irs.gov1040x   Members of the same controlled group of corporations are treated as one taxpayer when figuring the depletable oil or natural gas quantity. Www.irs.gov1040x They share the depletable quantity. Www.irs.gov1040x A controlled group of corporations is defined in section 1563(a) of the Internal Revenue Code, except that, for this purpose, the stock ownership requirement in that definition is “more than 50%” rather than “at least 80%. Www.irs.gov1040x ” Gross income from the property. Www.irs.gov1040x   For purposes of percentage depletion, gross income from the property (in the case of oil and gas wells) is the amount you receive from the sale of the oil or gas in the immediate vicinity of the well. Www.irs.gov1040x If you do not sell the oil or gas on the property, but manufacture or convert it into a refined product before sale or transport it before sale, the gross income from the property is the representative market or field price (RMFP) of the oil or gas, before conversion or transportation. Www.irs.gov1040x   If you sold gas after you removed it from the premises for a price that is lower than the RMFP, determine gross income from the property for percentage depletion purposes without regard to the RMFP. Www.irs.gov1040x   Gross income from the property does not include lease bonuses, advance royalties, or other amounts payable without regard to production from the property. Www.irs.gov1040x Average daily production exceeds depletable quantities. Www.irs.gov1040x   If your average daily production for the year is more than your depletable oil or natural gas quantity, figure your allowance for depletion for each domestic oil or natural gas property as follows. Www.irs.gov1040x Figure your average daily production of oil or natural gas for the year. Www.irs.gov1040x Figure your depletable oil or natural gas quantity for the year. Www.irs.gov1040x Figure depletion for all oil or natural gas produced from the property using a percentage depletion rate of 15%. Www.irs.gov1040x Multiply the result figured in (3) by a fraction, the numerator of which is the result figured in (2) and the denominator of which is the result figured in (1). Www.irs.gov1040x This is your depletion allowance for that property for the year. Www.irs.gov1040x Taxable income limit. Www.irs.gov1040x   If you are an independent producer or royalty owner of oil and gas, your deduction for percentage depletion is limited to the smaller of the following. Www.irs.gov1040x 100% of your taxable income from the property figured without the deduction for depletion and the deduction for domestic production activities under section 199 of the Internal Revenue Code. Www.irs.gov1040x For a definition of taxable income from the property, see Taxable income limit , earlier, under Mineral Property. Www.irs.gov1040x 65% of your taxable income from all sources, figured without the depletion allowance, the deduction for domestic production activities, any net operating loss carryback, and any capital loss carryback. Www.irs.gov1040x You can carry over to the following year any amount you cannot deduct because of the 65%-of-taxable-income limit. Www.irs.gov1040x Add it to your depletion allowance (before applying any limits) for the following year. Www.irs.gov1040x Partnerships and S Corporations Generally, each partner or S corporation shareholder, and not the partnership or S corporation, figures the depletion allowance separately. Www.irs.gov1040x (However, see Electing large partnerships must figure depletion allowance , later. Www.irs.gov1040x ) Each partner or shareholder must decide whether to use cost or percentage depletion. Www.irs.gov1040x If a partner or shareholder uses percentage depletion, he or she must apply the 65%-of-taxable-income limit using his or her taxable income from all sources. Www.irs.gov1040x Partner's or shareholder's adjusted basis. Www.irs.gov1040x   The partnership or S corporation must allocate to each partner or shareholder his or her share of the adjusted basis of each oil or gas property held by the partnership or S corporation. Www.irs.gov1040x The partnership or S corporation makes the allocation as of the date it acquires the oil or gas property. Www.irs.gov1040x   Each partner's share of the adjusted basis of the oil or gas property generally is figured according to that partner's interest in partnership capital. Www.irs.gov1040x However, in some cases, it is figured according to the partner's interest in partnership income. Www.irs.gov1040x   The partnership or S corporation adjusts the partner's or shareholder's share of the adjusted basis of the oil and gas property for any capital expenditures made for the property and for any change in partnership or S corporation interests. Www.irs.gov1040x Recordkeeping. Www.irs.gov1040x Each partner or shareholder must separately keep records of his or her share of the adjusted basis in each oil and gas property of the partnership or S corporation. Www.irs.gov1040x The partner or shareholder must reduce his or her adjusted basis by the depletion allowed or allowable on the property each year. Www.irs.gov1040x The partner or shareholder must use that reduced adjusted basis to figure cost depletion or his or her gain or loss if the partnership or S corporation disposes of the property. Www.irs.gov1040x Reporting the deduction. Www.irs.gov1040x   Information that you, as a partner or shareholder, use to figure your depletion deduction on oil and gas properties is reported by the partnership or S corporation on Schedule K-1 (Form 1065) or on Schedule K-1 (Form 1120S). Www.irs.gov1040x Deduct oil and gas depletion for your partnership or S corporation interest on Schedule E (Form 1040). Www.irs.gov1040x The depletion deducted on Schedule E is included in figuring income or loss from rental real estate or royalty properties. Www.irs.gov1040x The instructions for Schedule E explain where to report this income or loss and whether you need to file either of the following forms. Www.irs.gov1040x Form 6198, At-Risk Limitations. Www.irs.gov1040x Form 8582, Passive Activity Loss Limitations. Www.irs.gov1040x Electing large partnerships must figure depletion allowance. Www.irs.gov1040x   An electing large partnership, rather than each partner, generally must figure the depletion allowance. Www.irs.gov1040x The partnership figures the depletion allowance without taking into account the 65-percent-of-taxable-income limit and the depletable oil or natural gas quantity. Www.irs.gov1040x Also, the adjusted basis of a partner's interest in the partnership is not affected by the depletion allowance. Www.irs.gov1040x   An electing large partnership is one that meets both the following requirements. Www.irs.gov1040x The partnership had 100 or more partners in the preceding year. Www.irs.gov1040x The partnership chooses to be an electing large partnership. Www.irs.gov1040x Disqualified persons. Www.irs.gov1040x   An electing large partnership does not figure the depletion allowance of its partners that are disqualified persons. Www.irs.gov1040x Disqualified persons must figure it themselves, as explained earlier. Www.irs.gov1040x   All the following are disqualified persons. Www.irs.gov1040x Refiners who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Www.irs.gov1040x Retailers who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Www.irs.gov1040x Any partner whose average daily production of domestic crude oil and natural gas is more than 500 barrels during the tax year in which the partnership tax year ends. Www.irs.gov1040x Average daily production is discussed earlier. Www.irs.gov1040x Natural Gas Wells You can use percentage depletion for a well that produces natural gas that is either Sold under a fixed contract, or Produced from geopressured brine. Www.irs.gov1040x Natural gas sold under a fixed contract. Www.irs.gov1040x   Natural gas sold under a fixed contract qualifies for a percentage depletion rate of 22%. Www.irs.gov1040x This is domestic natural gas sold by the producer under a contract that does not provide for a price increase to reflect any increase in the seller's tax liability because of the repeal of percentage depletion for gas. Www.irs.gov1040x The contract must have been in effect from February 1, 1975, until the date of sale of the gas. Www.irs.gov1040x Price increases after February 1, 1975, are presumed to take the increase in tax liability into account unless demonstrated otherwise by clear and convincing evidence. Www.irs.gov1040x Natural gas from geopressured brine. Www.irs.gov1040x   Qualified natural gas from geopressured brine is eligible for a percentage depletion rate of 10%. Www.irs.gov1040x This is natural gas that is both the following. Www.irs.gov1040x Produced from a well you began to drill after September 1978 and before 1984. Www.irs.gov1040x Determined in accordance with section 503 of the Natural Gas Policy Act of 1978 to be produced from geopressured brine. Www.irs.gov1040x Mines and Geothermal Deposits Certain mines, wells, and other natural deposits, including geothermal deposits, qualify for percentage depletion. Www.irs.gov1040x Mines and other natural deposits. Www.irs.gov1040x   For a natural deposit, the percentage of your gross income from the property that you can deduct as depletion depends on the type of deposit. Www.irs.gov1040x   The following is a list of the percentage depletion rates for the more common minerals. Www.irs.gov1040x DEPOSITS RATE Sulphur, uranium, and, if from deposits in the United States, asbestos, lead ore, zinc ore, nickel ore, and mica 22% Gold, silver, copper, iron ore, and certain oil shale, if from deposits in the United States 15% Borax, granite, limestone, marble, mollusk shells, potash, slate, soapstone, and carbon dioxide produced from a well 14% Coal, lignite, and sodium chloride 10% Clay and shale used or sold for use in making sewer pipe or bricks or used or sold for use as sintered or burned lightweight aggregates 7½% Clay used or sold for use in making drainage and roofing tile, flower pots, and kindred products, and gravel, sand, and stone (other than stone used or sold for use by a mine owner or operator as dimension or ornamental stone) 5%   You can find a complete list of minerals and their percentage depletion rates in section 613(b) of the Internal Revenue Code. Www.irs.gov1040x Corporate deduction for iron ore and coal. Www.irs.gov1040x   The percentage depletion deduction of a corporation for iron ore and coal (including lignite) is reduced by 20% of: The percentage depletion deduction for the tax year (figured without this reduction), minus The adjusted basis of the property at the close of the tax year (figured without the depletion deduction for the tax year). Www.irs.gov1040x Gross income from the property. Www.irs.gov1040x   For property other than a geothermal deposit or an oil or gas well, gross income from the property means the gross income from mining. Www.irs.gov1040x Mining includes all the following. Www.irs.gov1040x Extracting ores or minerals from the ground. Www.irs.gov1040x Applying certain treatment processes described later. Www.irs.gov1040x Transporting ores or minerals (generally, not more than 50 miles) from the point of extraction to the plants or mills in which the treatment processes are applied. Www.irs.gov1040x Excise tax. Www.irs.gov1040x   Gross income from mining includes the separately stated excise tax received by a mine operator from the sale of coal to compensate the operator for the excise tax the mine operator must pay to finance black lung benefits. Www.irs.gov1040x Extraction. Www.irs.gov1040x   Extracting ores or minerals from the ground includes extraction by mine owners or operators of ores or minerals from the waste or residue of prior mining. Www.irs.gov1040x This does not apply to extraction from waste or residue of prior mining by the purchaser of the waste or residue or the purchaser of the rights to extract ores or minerals from the waste or residue. Www.irs.gov1040x Treatment processes. Www.irs.gov1040x   The processes included as mining depend on the ore or mineral mined. Www.irs.gov1040x To qualify as mining, the treatment processes must be applied by the mine owner or operator. Www.irs.gov1040x For a listing of treatment processes considered as mining, see section 613(c)(4) of the Internal Revenue Code and the related regulations. Www.irs.gov1040x Transportation of more than 50 miles. Www.irs.gov1040x   If the IRS finds that the ore or mineral must be transported more than 50 miles to plants or mills to be treated because of physical and other requirements, the additional authorized transportation is considered mining and included in the computation of gross income from mining. Www.irs.gov1040x    If you wish to include transportation of more than 50 miles in the computation of gross income from mining, request an advance ruling from the IRS. Www.irs.gov1040x Include in the request the facts about the physical and other requirements that prevented the construction and operation of the plant within 50 miles of the point of extraction. Www.irs.gov1040x For more information about requesting an advance ruling, see Revenue Procedure 2013-1, available at www. Www.irs.gov1040x irs. Www.irs.gov1040x gov/irb/2013-01_IRB/ar11. Www.irs.gov1040x html. Www.irs.gov1040x Disposal of coal or iron ore. Www.irs.gov1040x   You cannot take a depletion deduction for coal (including lignite) or iron ore mined in the United States if both the following apply. Www.irs.gov1040x You disposed of it after holding it for more than 1 year. Www.irs.gov1040x You disposed of it under a contract under which you retain an economic interest in the coal or iron ore. Www.irs.gov1040x Treat any gain on the disposition as a capital gain. Www.irs.gov1040x Disposal to related person. Www.irs.gov1040x   This rule does not apply if you dispose of the coal or iron ore to one of the following persons. Www.irs.gov1040x A related person (as listed in chapter 2 of Publication 544). Www.irs.gov1040x A person owned or controlled by the same interests that own or control you. Www.irs.gov1040x Geothermal deposits. Www.irs.gov1040x   Geothermal deposits located in the United States or its possessions qualify for a percentage depletion rate of 15%. Www.irs.gov1040x A geothermal deposit is a geothermal reservoir of natural heat stored in rocks or in a watery liquid or vapor. Www.irs.gov1040x For percentage depletion purposes, a geothermal deposit is not considered a gas well. Www.irs.gov1040x   Figure gross income from the property for a geothermal steam well in the same way as for oil and gas wells. Www.irs.gov1040x See Gross income from the property , earlier, under Oil and Gas Wells. Www.irs.gov1040x Percentage depletion on a geothermal deposit cannot be more than 50% of your taxable income from the property. Www.irs.gov1040x Lessor's Gross Income In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Www.irs.gov1040x A lessor's gross income from the property that qualifies for percentage depletion usually is the total of the royalties received from the lease. Www.irs.gov1040x Bonuses and advanced royalties. Www.irs.gov1040x   Bonuses and advanced royalties are payments a lessee makes before production to a lessor for the grant of rights in a lease or for minerals, gas, or oil to be extracted from leased property. Www.irs.gov1040x If you are the lessor, your income from bonuses and advanced royalties received is subject to an allowance for depletion, as explained in the next two paragraphs. Www.irs.gov1040x Figuring cost depletion. Www.irs.gov1040x   To figure cost depletion on a bonus, multiply your adjusted basis in the property by a fraction, the numerator of which is the bonus and the denominator of which is the total bonus and royalties expected to be received. Www.irs.gov1040x To figure cost depletion on advanced royalties, use the computation explained earlier under Cost Depletion , treating the number of units for which the advanced royalty is received as the number of units sold. Www.irs.gov1040x Figuring percentage depletion. Www.irs.gov1040x   In the case of mines, wells, and other natural deposits other than gas, oil, or geothermal property, you may use the percentage rates discussed earlier under Mines and Geothermal Deposits . Www.irs.gov1040x Any bonus or advanced royalty payments are generally part of the gross income from the property to which the rates are applied in making the calculation. Www.irs.gov1040x However, for oil, gas, or geothermal property, gross income does not include lease bonuses, advanced royalties, or other amounts payable without regard to production from the property. Www.irs.gov1040x Ending the lease. Www.irs.gov1040x   If you receive a bonus on a lease that ends or is abandoned before you derive any income from mineral extraction, include in income the depletion deduction you took. Www.irs.gov1040x Do this for the year the lease ends or is abandoned. Www.irs.gov1040x Also increase your adjusted basis in the property to restore the depletion deduction you previously subtracted. Www.irs.gov1040x   For advanced royalties, include in income the depletion claimed on minerals for which the advanced royalties were paid if the minerals were not produced before the lease ended. Www.irs.gov1040x Include this amount in income for the year the lease ends. Www.irs.gov1040x Increase your adjusted basis in the property by the amount you include in income. Www.irs.gov1040x Delay rentals. Www.irs.gov1040x   These are payments for deferring development of the property. Www.irs.gov1040x Since delay rentals are ordinary rent, they are ordinary income that is not subject to depletion. Www.irs.gov1040x These rentals can be avoided by either abandoning the lease, beginning development operations, or obtaining production. Www.irs.gov1040x Timber You can figure timber depletion only by the cost method. Www.irs.gov1040x Percentage depletion does not apply to timber. Www.irs.gov1040x Base your depletion on your cost or other basis in the timber. Www.irs.gov1040x Your cost does not include the cost of land or any amounts recoverable through depreciation. Www.irs.gov1040x Depletion takes place when you cut standing timber. Www.irs.gov1040x You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation. Www.irs.gov1040x Figuring cost depletion. Www.irs.gov1040x   To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit. Www.irs.gov1040x Timber units. Www.irs.gov1040x   When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. Www.irs.gov1040x You measure the timber using board feet, log scale, cords, or other units. Www.irs.gov1040x If you later determine that you have more or less units of timber, you must adjust the original estimate. Www.irs.gov1040x   The term “timber property” means your economic interest in standing timber in each tract or block representing a separate timber account. Www.irs.gov1040x Depletion unit. Www.irs.gov1040x   You figure your depletion unit each year by taking the following steps. Www.irs.gov1040x Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Www.irs.gov1040x Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property. Www.irs.gov1040x Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital. Www.irs.gov1040x 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. Www.irs.gov1040x Divide the result of (2) by the result of (3). Www.irs.gov1040x This is your depletion unit. Www.irs.gov1040x Example. Www.irs.gov1040x You bought a timber tract for $160,000 and the land was worth as much as the timber. Www.irs.gov1040x Your basis for the timber is $80,000. Www.irs.gov1040x Based on an estimated one million board feet (1,000 MBF) of standing timber, you figure your depletion unit to be $80 per MBF ($80,000 ÷ 1,000). Www.irs.gov1040x If you cut 500 MBF of timber, your depletion allowance would be $40,000 (500 MBF × $80). Www.irs.gov1040x When to claim depletion. Www.irs.gov1040x   Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Www.irs.gov1040x 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. Www.irs.gov1040x The inventory is your basis for determining gain or loss in the tax year you sell the timber products. Www.irs.gov1040x Example. Www.irs.gov1040x The facts are the same as in the previous example except that you sold only half of the timber products in the cutting year. Www.irs.gov1040x You would deduct $20,000 of the $40,000 depletion that year. Www.irs.gov1040x You would add the remaining $20,000 depletion to your closing inventory of timber products. Www.irs.gov1040x Electing to treat the cutting of timber as a sale or exchange. Www.irs.gov1040x   You can elect, under certain circumstances, to treat the cutting of timber held for more than 1 year as a sale or exchange. Www.irs.gov1040x You must make the election on your income tax return for the tax year to which it applies. Www.irs.gov1040x If you make this election, subtract the adjusted basis for depletion from the fair market value of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. Www.irs.gov1040x You generally report the gain as long-term capital gain. Www.irs.gov1040x The fair market value then becomes your basis for figuring your ordinary gain or loss on the sale or other disposition of the products cut from the timber. Www.irs.gov1040x For more information, see Timber in chapter 2 of Publication 544, Sales and Other Dispositions of Assets. Www.irs.gov1040x   You may revoke an election to treat the cutting of timber as a sale or exchange without IRS's consent. Www.irs.gov1040x The prior election (and revocation) is disregarded for purposes of making a subsequent election. Www.irs.gov1040x See Form T (Timber), Forest Activities Schedule, for more information. Www.irs.gov1040x Form T. Www.irs.gov1040x   Complete and attach Form T (Timber) to your income tax return if you claim a deduction for timber depletion, choose to treat the cutting of timber as a sale or exchange, or make an outright sale of timber. Www.irs.gov1040x Prev  Up  Next   Home   More Online Publications
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