Cost depletion allows for the recovery of the actual capital investment-the costs of discovering, purchasing, and developing the well-over the period the well produces income.
In 1926, Congress introduced the "excess of percentage over
cost depletion deferral," a.
The amount of taxable royalties, but not land lease payments, may be reduced by a depletion deduction, calculated either under the percentage depletion method or the
cost depletion method.
As discussed below, qualification for the bulk sale exception directly affects the taxpayer's ability to use the most advantageous method of calculation for
cost depletion.
There are a number of deductions specific to the oil and gas industry, such as the ability to expense intangible drilling costs (IDCs) and to claim percentage depletion instead of
cost depletion.
Cost depletion essentially involves recovery of a portion of the taxpayer's adjusted basis each year, based on the amount of oil or gas recovered for that year and the total anticipated production.
16 There are two different types of depletion:
cost depletion and percentage depletion.
Stated as a formula,
cost depletion for the tax year is computed as follows:
Other states require capitalization of intangible drilling costs or the use of
cost depletion.
Depletion after 1989 is
cost depletion, which had previously been the same method used for regular tax purposes.
Others may use
cost depletion deduction which is limited to the taxpayer's cost basis in the property.
Although there are two available methods of depletion,
cost depletion and percentage depletion, generally oil and gas operations may use only the
cost depletion method (Regs.
