what is depletion

Discussion in 'Tax' started by removeps-groups, May 13, 2011.

  1. what is depletion? It shows up on forms like Schedule C and is
    evidently a tax break for oil companies. Is it like depreciation that
    has to paid back? How is it calculated?
     
    removeps-groups, May 13, 2011
    #1
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  2. removeps-groups

    JoeTaxpayer Guest

    http://www.investopedia.com/terms/d/depletion.asp
     
    JoeTaxpayer, May 13, 2011
    #2
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  3. I'm not an expert on this. But as I recall it is an alternative to
    depreciation. For oil companies they get to deduct a percentage of
    the value of the oil they get. It is unrelated to actual cost, and
    they get to keep taking it even after all their costs have been
    deducted. I am not aware that it is ever recaptured.
     
    Stuart Bronstein, May 13, 2011
    #3

  4. Depletion is similar to depreciation in that it is an accounting
    device designed to match the recovery of the cost of an asset
    (depletable natural resources) with the income the asset produces over
    the asset's useful life or existence.

    Cost depletion is based on units of production and is limited to the
    total cost of the resource. So I can write off the cost of the
    resource as I recover and sell it.

    Percentage depletion is one of those tax gimmicks allowed to the oil
    and gas industry (and somewhat less generously to producers of
    minerals, etc.) that were the subject of the Congressional hearings
    yesterday. Instead of recovering a fixed cost as the resource is
    depleted, the taxpayer is allowed to claim a statutory percentage of
    the gross income from the property. Oil and gas gets a depletion
    deduction of 22% of gross income, as long as the property continues to
    produce income. The total deductions over the life of the property
    are not limited to the taxpayer's cost. There are limitations,
    however, on how much percentage depletion can be deducted each year.

    Here is a link to a site that provides examples calculating cost and
    percentage depletion: http://taxpoint.swcollege.com/taxpoint_2001/student/m10/m10-6.html

    Katie in San Diego
     
    Katie in San Diego, May 13, 2011
    #4
  5. removeps-groups

    D. Stussy Guest

    It is similar. Instead of expensing "use", it is expensing the removal
    value of minerals (or oil or timber) from the land itself.
     
    D. Stussy, May 13, 2011
    #5
  6. removeps-groups

    AES Guest

    It is similar. Instead of expensing "use", it is expensing the removal
    value of minerals (or oil or timber) from the land itself.[/QUOTE]

    Just for educational purposes, let me ask: If I (as an individual) buy
    a small rental property, or a computer to use in consulting work, I'm
    able to depreciate over time more or less the amount I paid for that
    asset -- but not more.

    But suppose a big oil or mining company buys a piece of property, or the
    oil or mineral rights in a piece of property for a certain amount, and
    begins drilling or digging, with substantial success in this endeavor.
    As times goes on, I'm guessing that over and above deductible operating
    expenses, they can take depletion expenses or deductions for vastly more
    than they actually paid for the property or the rights. Is that a fair
    assumption?
     
    AES, May 13, 2011
    #6
  7. Just for educational purposes, let me ask:  If I (as an individual) buy
    a small rental property, or a computer to use in consulting work, I'm
    able to depreciate over time more or less the amount I paid for that
    asset -- but not more.

    But suppose a big oil or mining company buys a piece of property, or the
    oil or mineral rights in a piece of property for a certain amount, and
    begins drilling or digging, with substantial success in this endeavor.  
    As times goes on, I'm guessing that over and above deductible operating
    expenses, they can take depletion expenses or deductions for vastly more
    than they actually paid for the property or the rights.  Is that a fair
    assumption?
    [/QUOTE]


    Yes. The amount deductible as percentage depletion, where that is
    allowed, is not limited to the cost of the property or the drilling/
    mining rights. Also, the depletion allowance is based on the sales
    revenue from the product, which is unrelated to its cost. For
    example, if you bought drilling rights to an O&G property when oil was
    selling for $20 a barrel, and you sell (just for round numbers) 1,000
    barrels a year, your depletion deduction for Year 1 would be $4,400
    (22% of $20,000 sales revenue.) But in a later year when oil sells
    for $100 a barrel, your depletion deduction would be $22,000 (22% of
    $100,000). Of course your deduction might be otherwise limited; for
    example, the deduction is limited to 50% of the net income from the
    property.

    Katie in San Diego
     
    Katie in San Diego, May 13, 2011
    #7
  8. removeps-groups

    D. Stussy Guest

    Note that in that example, what was "bought" by the miner was the RIGHT to
    extract, and not title to the land itself. Rent paid for mining rights is
    excluded from the net income computation. In some places, it is possible
    to buy mining rights without title to the land [surface] itself.
     
    D. Stussy, May 13, 2011
    #8
  9. So do oil companies deduct their drilling costs (labor, depreciation
    of equipment) as well as take this depletion deduction? And if they
    get to deduct drilling costs do they incorporate it into the cost of
    goods sold or as a current expense?
    Why do you say "my example"? Did you define the scenario elsewhere.

    It sounds like you're saying that an oil producer cannot deduct rent,
    but must take depletion instead. Is that so? However, the person
    receiving rent, would they report income on their Schedule E?

    Finally, I notice that depletion occurs on the AMT form 6251. This is
    strange for two reasons. First, it is strange for a person running an
    oil business to use Schedule C (one would imagine they run a
    corporation), but I suppose if they get a K-1 from an LLC then it
    might matter. Second, does the personal AMT tax (form 6251) or
    corporate AMT limit the depletion deduction.
     
    removeps-groups, May 14, 2011
    #9
  10. ====
    Small producers can take percentage depletion, which could exceed the cost,
    but major integrated oil companies MUST take cost depletion and it cannot
    exceed cost.
    Royalty owners can take 15% depletion.
     
    Craig's Proctologist, May 14, 2011
    #10
  11. removeps-groups

    D. Stussy Guest

    It's not your example. Read the tread, and an example was inserted in
    another reply.
    Rent is not deductible for computing net income subject to depletion.
    Rent is deductible for computing net income subject to tax.
    Limit? No. However, depletion for AMTI may be different than for the
    regular tax.
     
    D. Stussy, May 15, 2011
    #11
  12. removeps-groups

    dpb Guest

    On 5/13/2011 3:44 PM, AES wrote:
    ....
    True, but...it's not unlimited.

    As of the last time I looked (sometime within the last couple of years,
    but not just within the last few months) at the information in the local
    area royalty owners' annual meeting packet, the following was given--I
    don't think it's changed much--yet. Hmmmm.....looking at the footnotes,
    I guess this must have been the 2009 meeting.

    Now granted, the following was prepared as a response to the current
    administration's having floated the trial balloon of reducing or
    eliminating the depletion allowance but it I think outlines at least
    part of the impact on US production if it were to be eliminated.

    I'll note that while there is activity again in the oil patch around
    here owing to the current market prices, even in the period when prices
    fell back earlier from previous peaks it was clearly obvious that
    activity was scaled back nearly immediately by quite significant
    amounts. These small operators would really back off if the depletion
    allowance were also to go away unless market prices remained very high;
    probably far higher than we would like to see as consumers.

    --
     
    dpb, May 17, 2011
    #12
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