||2008 Tax Year
Marginal production of oil and gas. For tax years beginning after December 31, 2007, the temporary suspension of the taxable income limit on percentage depletion
from the marginal
production of oil and natural gas is scheduled to expire. See Percentage 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.
Topics - This chapter discusses:
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 any interest in mineral deposits or standing timber.
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
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
Individuals, corporations, estates, and trusts who claim depletion deductions may be liable for alternative minimum tax.
Mineral property includes oil and gas wells, mines, and other natural deposits (including geothermal deposits). For this purpose,
“property” means each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two
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.
There are two ways of figuring depletion on mineral property.
Generally, you must use the method that gives you the larger deduction. However, unless you are an independent producer or
royalty owner, you
generally cannot use percentage depletion for oil and gas wells. See Oil and Gas Wells, later.
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.
Basis for depletion.
To figure the property's basis for depletion, subtract all the following from the property's adjusted basis.
Amounts recoverable through:
Deferred expenses (including deferred exploration and development costs), and
Deductions other than depletion.
The residual value of land and improvements at the end of operations.
The cost or value of land acquired for purposes other than mineral production.
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. Your adjusted basis can never be less than zero. See Publication
551, Basis of Assets, for
more information on adjusted basis.
Total recoverable units.
The total recoverable units is the sum of the following.
The number of units of mineral remaining at the end of the year (including units recovered but not sold).
The number of units of mineral sold during the tax year (determined under your method of accounting, as explained next).
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.
Number of units sold.
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.
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
An accrual method of accounting
The units sold based on your inventories and method of accounting for
The number of units sold during the tax year does not include any for 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.
Divide your property's
basis for depletion by
total recoverable units.
Rate per unit.
Multiply the rate per
unit by units sold
during the tax year.
Cost depletion deduction.
You must keep accounts for the depletion of each property and adjust these accounts each year for units sold and depletion
Elective safe harbor for owners of oil and gas property.
Owners of oil and gas property may use an elective safe harbor in determining the property's recoverable reserves
for purposes of computing cost
depletion. If this election is made, special rules apply. See Revenue Procedure 2004-19 on page 563 of Internal Revenue Bulletin
2004-10, available at
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. The statement must indicate that you are electing the safe harbor provided by Revenue Procedure 2004-19.
The election, if made, is
effective for the tax year in which it is made and all subsequent years. It cannot be revoked for the tax year in which it
is elected, but may be
revoked in a later year. Once revoked, it cannot be re-elected for the next 5 years.
To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the
property during the
The rates to be used and other conditions and qualifications for oil and gas wells are discussed later 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.
When figuring your percentage depletion, subtract from your gross income from the property the following amounts.
Any rents or royalties you paid or incurred for the property.
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.
A bonus payment includes amounts you paid as a lessee to satisfy a production payment retained by the lessor.
Use the following fraction to figure the part of the bonus you must subtract.
|No. of units sold in the tax year
Recoverable units from the property
For oil and gas wells and geothermal deposits, gross income from the property is defined later under Oil and Gas Wells
. For property
other than a geothermal deposit or an oil and gas well, gross income from the property is defined later under Mines and Geothermal
Taxable income limit.
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.
Taxable income from the property means gross income from the property minus all allowable deductions (excluding any
deduction for depletion or
qualified domestic production activities) attributable to mining processes, including mining transportation. These deductible
items include, but are
not limited to, the following.
Certain selling expenses.
Administrative and financial overhead.
Intangible drilling and development costs.
Exploration and development expenditures.
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 dispose of an item of section 1245 property that was used in connection with mineral property, reduce
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.
You cannot claim percentage depletion for an oil or gas well unless at least one of the following applies.
If you are an independent producer or royalty owner, see Independent Producers and Royalty Owners, next.
For information on the depletion deduction for wells that produce natural gas that is either sold under a fixed contract or
geopressured brine, see Natural Gas Wells, later.
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. However,
certain refiners, as explained next, and certain retailers and transferees of proven oil and gas properties, as explained
later, cannot claim
percentage depletion. For information on figuring the deduction, see Figuring percentage depletion, later.
Refiners who cannot claim percentage depletion.
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. 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.
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.
For example, a corporation, partnership, estate, or trust and anyone who holds a significant ownership interest in it are
related persons. A
partnership and a trust are related persons if one person holds a significant ownership interest in each of them.
For purposes of the related person rules, significant ownership interest means direct or indirect ownership of 5% or more
in any one of the
The value of the outstanding stock of a corporation.
The interest in the profits or capital of a partnership.
The beneficial interests in an estate or trust.
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.
Retailers who cannot claim percentage depletion.
You cannot claim percentage depletion if both the following apply.
You sell oil or natural gas or their by-products directly or through a related person in any of the following situations.
Through a retail outlet operated by you or a related person.
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.
To any person given authority under an agreement with you or a related person to occupy any retail outlet owned, leased, or
you or a related person.
The combined gross receipts from sales (not counting resales) of oil, natural gas, or their by-products by all retail outlets
account in (1) are more than $5 million for the tax year.
For the purpose of determining if this rule applies, do not count the following.
Bulk sales (sales in very large quantities) of oil or natural gas to commercial or industrial users.
Bulk sales of aviation fuels to the Department of Defense.
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.
To determine if you and another person are related persons, see Related person
under Refiners who cannot claim percentage
Sales through a related person.
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.
You are not
considered to be selling through a related person who is a retailer if all the following apply.
You do not have a significant ownership interest in the retailer.
You sell your production to persons who are not related to either you or the retailer.
The retailer does not buy oil or natural gas from your customers or persons related to your customers.
There are no arrangements for the retailer to acquire oil or natural gas you produced for resale or made available for purchase
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.
Transferees who cannot claim percentage depletion.
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. For a definition of the term “transfer,
” see section 1.613A-7(n) of the regulations. For a definition of the term “interest in proven oil
or gas property,
” see section 1.613A-7(p) of the regulations.
Figuring percentage depletion.
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. 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%. 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 exceeds depletable quantities.
In addition, there is a limit on the percentage depletion deduction. See Taxable income limit,
Average daily production.
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
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.
You have a partial interest in the production from a property if you have a net profits interest in the property.
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. To figure this percentage, you divide the income you receive for your net profits interest by the gross revenue
from the property. Then
multiply the total production from the property by your percentage participation to figure your share of the production.
John Oak owns oil property in which Paul Elm owns a 20% net profits interest. During the year, the property produced 10,000
barrels of oil, which
John sold for $200,000. John had expenses of $90,000 attributable to the property. The property generated a net profit of
$110,000 ($200,000 -
$90,000). Paul received income of $22,000 ($110,000 × .20) for his net profits interest.
Paul determined his percentage participation to be 11% by dividing $22,000 (the income he received) by $200,000 (the gross
revenue from the
property). Paul determined his share of the oil production to be 1,100 barrels (10,000 barrels × 11%).
Depletable oil or natural gas quantity.
Generally, your depletable oil quantity is 1,000 barrels. 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. 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.
You have both oil and natural gas production. To figure your depletable natural gas quantity, you choose to apply 360 barrels
of your 1000-barrel
depletable oil quantity. Your depletable natural gas quantity is 2.16 million cubic feet of gas (360 × 6000). You must reduce
oil quantity to 640 barrels (1000 - 360).
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
Business entities and family members.
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.
Corporations, trusts, and estates if 50% or more of the beneficial interest is owned by the same or related persons (considering
persons that own at least 5% of the beneficial interest).
You and your spouse and minor children.
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
Controlled group of corporations.
Members of the same controlled group of corporations are treated as one taxpayer when figuring the depletable oil
or natural gas quantity. They
share the depletable quantity. Under this rule, a controlled group of corporations is defined in section 1563(a) of the Internal
Revenue Code, except
that the stock ownership requirement in that definition is “more than 50%
” rather than “at least 80%.
Gross income from the property.
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. 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.
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.
Gross income from the property does not include lease bonuses, advance royalties, or other amounts payable without
regard to production from the
Average daily production exceeds depletable quantities.
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.
Figure your average daily production of oil or natural gas for the year.
Figure your depletable oil or natural gas quantity for the year.
Figure depletion for all oil or natural gas produced from the property using a percentage depletion rate of 15%.
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). This is your depletion allowance for that property for the year.
Taxable income limit.
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
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. For a definition of taxable income from the property, see Taxable income limit,
earlier, under Mineral Property.
65% of your taxable income from all sources, figured without the depletion allowance, the deduction for domestic production
net operating loss carryback, and any capital loss carryback.
You can carry over to the following year any amount you cannot deduct because of the 65%-of-taxable-income limit. Add it to
allowance (before applying any limits) for the following year.
For tax years beginning before January 1, 2008, depletion on the marginal production of oil or natural gas is not limited
to your taxable income
from the property figured without the depletion deduction. For information on marginal production, see section 613A(c)(6)
of the Internal Revenue
Partnerships and S Corporations
Generally, each partner or shareholder, and not the partnership or S corporation, figures the depletion allowance separately.
Electing large partnerships must figure depletion allowance, later.) Each partner or shareholder must decide whether to use cost or
percentage depletion. 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.
Partner's or shareholder's adjusted basis.
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. The partnership or S corporation makes the allocation as of the date it acquires
the oil or gas property.
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. However, in some cases, it is figured according to the partner's interest in partnership income.
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.
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. The partner or shareholder must reduce his or her adjusted basis by the depletion allowed or allowable on
the property each year.
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.
Reporting the deduction.
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). Deduct oil and gas depletion for your partnership
or S corporation
interest on Schedule E (Form 1040). The depletion deducted on Schedule E is included in figuring income or loss from rental
real estate or royalty
properties. The instructions for Schedule E explain where to report this income or loss and whether you need to file either
of the following forms.
Form 6198, At-Risk Limitations.
Form 8582, Passive Activity Loss Limitations.
Electing large partnerships must figure depletion allowance.
An electing large partnership, rather than each partner, generally must figure the depletion allowance. 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.
Also, the adjusted basis
of a partner's interest in the partnership is not affected by the depletion allowance.
An electing large partnership is one that meets both the following requirements.
An electing large partnership does not figure the depletion allowance of its partners that are disqualified persons.
Disqualified persons must
figure it themselves, as explained earlier.
All the following are disqualified persons.
Refiners who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners, earlier).
Retailers who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners, earlier).
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. Average daily production is discussed earlier.
You can use percentage depletion for a well that produces natural gas either sold under a fixed contract or produced from
Natural gas sold under a fixed contract.
Natural gas sold under a fixed contract qualifies for a percentage depletion rate of 22%. 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
depletion for gas. The contract must have been in effect from February 1, 1975, until the date of sale of the gas. Price increases
after February 1,
1975, are presumed to take the increase in tax liability into account unless demonstrated otherwise by clear and convincing
Natural gas from geopressured brine.
Qualified natural gas from geopressured brine is eligible for a percentage depletion rate of 10%. This is natural
gas that is both the following.
Mines and Geothermal Deposits
Certain mines, wells, and other natural deposits, including geothermal deposits, qualify for percentage depletion.
Mines and other natural deposits.
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.
The following is a list of the percentage depletion rates for the more common minerals.
Sulphur, uranium, and, if from deposits in the United States, asbestos, lead ore, zinc ore, nickel ore, and mica
Gold, silver, copper, iron ore, and certain oil shale, if from deposits in the United States
Borax, granite, limestone, marble, mollusk shells, potash, slate, soapstone, and carbon dioxide produced from a
Coal, lignite, and sodium chloride
Clay and shale used or sold for use in making sewer pipe or bricks or used or sold for use as sintered or burned
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)
You can find a complete list of minerals and their percentage depletion rates in section 613(b) of the Internal Revenue
Corporate deduction for iron ore and coal.
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 regard to 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).
Gross income from the property.
For property other than a geothermal deposit or an oil or gas well, gross income from the property means the gross
income from mining. Mining
includes all the following.
Extracting ores or minerals from the ground.
Applying certain treatment processes.
Transporting ores or minerals (generally, not more than 50 miles) from the point of extraction to the plants or mills in which
processes are applied.
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.
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. 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.
The processes included as mining depend on the ore or mineral mined. To qualify as mining, the treatment processes
must be applied by the mine
owner or operator. For a listing of treatment processes considered as mining, see section 613(c)(4) of the Internal Revenue
Code and the related
Transportation of more than 50 miles.
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
If you wish to include transportation of more than 50 miles in the computation of gross income from mining, file an application
in duplicate with
the IRS. Include on the application the facts concerning the physical and other requirements which prevented the construction
and operation of the
plant within 50 miles of the point of extraction. Send this application to:
Internal Revenue Service
Associate Chief Counsel
Passthroughs and Special Industries
1111 Constitution Ave., N.W., IR-5300
Washington, DC 20224
Disposal of coal or iron ore.
You cannot take a depletion deduction for coal (including lignite) or iron ore mined in the United States if both
the following apply.
Treat any gain on the disposition as a capital gain.
Disposal to related person.
This rule does not apply if you dispose of the coal or iron ore to one of the following persons.
Geothermal deposits located in the United States or its possessions qualify for a percentage depletion rate of 15%.
A geothermal deposit is a
geothermal reservoir of natural heat stored in rocks or in a watery liquid or vapor. For percentage depletion purposes, a
geothermal deposit is not
considered a gas well.
Figure gross income from the property for a geothermal steam well in the same way as for oil and gas wells. See Gross income from the
earlier, under Oil and Gas Wells.
Percentage depletion on a geothermal deposit cannot be more than 50% of your taxable
income from the property.
A lessor's gross income from the property that qualifies for percentage depletion usually is the total of the royalties received
from the lease.
However, for oil, gas, or geothermal property, gross income does not include lease bonuses, advanced royalties, or other amounts
regard to production from the property.
Bonuses and advanced royalties.
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. If you are the lessor, your income from bonuses and advanced royalties received
is subject to an
allowance for depletion.
Figuring cost depletion.
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. 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
Figuring percentage depletion.
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.
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. However, in the case of independent producers and royalty
owners of oil and gas
property, bonuses and advance royalty payments are not a part of gross income.
Terminating the lease.
If you receive a bonus on a lease that expires, terminates, or is abandoned before you derive any income from the
extraction of mineral, include in
income for the year of expiration, termination, or abandonment, the depletion deduction you took. Also increase your adjusted
basis in the property to
restore the depletion deduction you previously subtracted.
For advanced royalties, include in income for the year of lease termination, the depletion claimed on minerals for
which the advanced royalties
were paid if the minerals were not produced before termination. Increase your adjusted basis in the property by the amount
you include in income.
These are payments for deferring development of the property. Since delay rentals are ordinary rent, they are ordinary
income that is not subject
to depletion. These rentals can be avoided by either abandoning the lease, beginning development operations, or obtaining
You can figure timber depletion only by the cost method. Percentage depletion does not apply to timber. Base your depletion
on your cost or other
basis in the timber. Your cost does not include the cost of land or any amounts recoverable through depreciation.
Depletion takes place when you cut standing timber. You can figure your depletion deduction when the quantity of cut timber
is first accurately
measured in the process of exploitation.
Figuring cost depletion.
To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit.
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
The term “timber property
” means your economic interest in standing timber in each tract or block representing a separate timber account.
You figure your depletion unit each year by taking the following steps.
Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Adjusted basis is defined under
Depletion in the discussion on Mineral Property.
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.
You bought a timber tract for $160,000 and the land was worth as much as the timber. Your basis for the timber is $80,000.
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).
If you cut 500 MBF
of timber, your depletion allowance would be $40,000 (500 MBF × $80).
When to claim 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 choose to
treat the cutting of timber as a sale or exchange (explained below). 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.
Assume the same facts as in the previous example except that you sold only half of the timber products in the cutting year.
You would deduct
$20,000 of the $40,000 depletion that year. You would add the remaining $20,000 depletion to your closing inventory of timber
Electing to treat the cutting of timber as a sale or exchange.
You can elect, under certain circumstances, to treat the cutting of timber held for more than 1 year as a sale or
exchange. You must make the
election on your income tax return for the tax year to which it applies. 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.
You generally report
the gain as long-term capital gain. 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. For more information, see Timber
in chapter 2 of Publication 544, Sales and Other
Dispositions of Assets.
You may revoke an election to treat the cutting of timber as a sale or exchange without IRS's consent. The prior election
(and revocation) is
disregarded for purposes of making a subsequent election. See Form T (Timber), Forest Activities Schedule, for more information.
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.
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