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.
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 Lacerte, 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:
- Go to the Forms tab.
- Go to the Oil & Gas Sch.
- Under Description in the left navigation panel, select Inc. Limitation for Depletion.
- This worksheet shows the calculation for the income limitation.
In Screen 20, Passthrough K-1's in the Individual module, 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.