You can use either the cost depletion or percentage depletion method to calculate the oil and gas depletion deduction. The IRS allows taxpayers to use the method that results in the greatest deduction. However, there are more severe limitations on percentage depletion deductions. Refer to the IRS Oil and Gas Handbook for more information.
Deductions for oil and gas percentage depletion are limited in two ways:
- A maximum of 100% of the net taxable income the taxpayer received from the investment, computed without allowance for depletion.
- This doesn't include lease bonuses, advance royalties, or any amounts unrelated to actual production.
- 65% of the taxpayer's gross taxable income from all sources for the tax period.
If you enter information for both percentage depletion and cost depletion in ProConnect, the program will optimize and take the greater of the two. Then, it'll apply the 65% of taxable limitation for percentage depletion deductions. Anything in excess of the 65% limitation may be carried forward to future years.
Follow these steps to see the calculation for the limitation:
- From the Check Return tab, open the Forms section..
- Go to the Oil & Gas Sch.
- Select the Inc. Limitation for Depletion worksheet.
- This worksheet shows the calculation for the income limitation.
On the Passthrough K-1 screen in the individual return, there's a field to report the oil and gas depletion on Schedule E, page 1 as royalty. This can be confusing when there are multiple K-1's, so you should review both pages of Schedule E.
If you need assistance entering oil and gas information in the program, refer to this article for instructions.