{"id":8305,"date":"2017-05-16T08:00:56","date_gmt":"2017-05-16T13:00:56","guid":{"rendered":"http:\/\/taxprocenter.proconnect.intuit.com\/?p=8305"},"modified":"2019-06-18T10:17:10","modified_gmt":"2019-06-18T15:17:10","slug":"oil-and-gas-tax-in-a-nutshell-part-1","status":"publish","type":"post","link":"https:\/\/accountants.intuit.com\/taxprocenter\/tax-law-and-news\/oil-and-gas-tax-in-a-nutshell-part-1\/","title":{"rendered":"Oil and Gas Tax in a Nutshell \u2013 Part 1"},"content":{"rendered":"

This title may sound like an oxymoron \u2026 after all, entire courses are given on the topic of oil and gas tax. However, with a basic overview, you can have a starting point for a client coming to you with oil and gas information.<\/p>\n

Depletion is what makes oil and gas unique. What\u2019s that?<\/strong><\/p>\n

IRS Pub 535<\/a> states that \u201cdepletion is the using up of natural resources by mining, drilling, quarrying stone or cutting timber. The depletion deduction allows an owner or operator to account for the reduction of a product’s reserves.”<\/p>\n

Oil and gas rules say that you generally capitalize the costs to acquire, explore and develop oil and gas producing properties. These costs are usually referred to as capitalized leasehold costs.<\/strong><\/p>\n

Depletion is how those capitalized costs are claimed as a deduction, when the oil or gas well begins production, and is calculated and maintained on a property-by-property basis. The term \u201dproperty\u201d can mean each separate interest in each separate well. See IRC Sec. 614<\/a> for more details.<\/p>\n

Who can claim the depletion deduction? Whoever holds an \u201ceconomic interest\u201d in the property, or the right to income from the extraction of the minerals from the property.<\/p>\n

How is it calculated? There are two methods of depletion:<\/strong><\/p>\n

    \n
  1. Cost depletion<\/strong> is calculated from the capitalized costs, and is taken as the oil or gas is extracted from the property.<\/li>\n
  2. Percentage depletion<\/strong> gets its name from the fact that the deduction is based on a percentage (usually 15 percent) of gross income from the property (see limitations below). Because the starting point isn\u2019t capitalized on leasehold costs, you can get a percentage depletion even after capitalized costs have been recovered!<\/li>\n<\/ol>\n

    Which method of depletion should I use?<\/strong><\/p>\n

    If your client is an \u201cindependent producer\u201d [IRC Sec. 613A(d)<\/a>] or royalty owner, the best part of oil and gas is that you can use the better of both! You can deduct the higher of cost depletion or percentage depletion for each property. Because percentage depletion can be an amazing deduction, and rather complicated, let\u2019s explain percentage depletion.<\/p>\n

    Calculating percentage depletion<\/strong><\/p>\n

    Percentage depletion is calculated based on a percentage of gross income from the property, but it can only be taken on a property that has net income. It\u2019s important to note that percentage depletion uses the following definition of net income: Oil and gas gross revenue, less:<\/p>\n