Mineral Property The term "mineral property" means each separate interest youown in each mineral deposit in each separate tract or parcel of land.You can treat mineral properties separately or as a group. See section614 of the Internal Revenue Code for rules on how to treat separateproperties. Mineral property includes oil and gas wells, mines, and othernatural deposits (including geothermal deposits). There are two ways of figuring depletion on mineral property. Cost depletion. Percentage depletion. Generally, you must use the method that gives you the largerdeduction. However, unless you are a small producer or royalty owner,you generally cannot use percentage depletion for oil and gas wells.See Oil and Gas Wells, later. Cost Depletion To figure cost depletion you must first determine the following. The property's basis for depletion. The total recoverable units in the property's naturaldeposit. The number of units sold during the tax year. Basis for depletion.To figure the property's basis for depletion, subtract all of thefollowing from the property's adjusted basis. The amounts recoverable through: Depreciation deductions, Deferred expenses (including deferred exploration anddevelopment costs), and hotel rooms SchwechatDeductions other than depletion. The residual value of land and improvements at the end ofoperations. The cost or value of land acquired for purposes other thanmineral production. Adjusted basis.The adjusted basis of your property is your original cost or otherbasis, plus certain additions and improvements, and minus certaindeductions such as depletion allowed or allowable and casualty losses.Your adjusted basis can never be less than zero. See Publication 551,Basis of Assets, for more information on adjusted basis. Total recoverable units.The total recoverable units is the sum of the following two items. The number of units of mineral remaining at the end of theyear (including units recovered but not sold). The number of units sold during the tax year (determinedunder your method of accounting, as explained next). You must estimate or determine recoverable units (tons, pounds,ounces, barrels, thousands of cubic feet, or other measure) of mineralproducts using the current industry method and using the most accurateand reliable information you can obtain. Number of units sold.The number of units sold during the tax year is one of thefollowing. The units sold for which you receive payment during your taxyear (regardless of the year of sale), if you use the cash method ofaccounting. The units sold based on your inventories, if you use theaccrual method of accounting. The number of units sold during the tax year does not include anyon which depletion deductions were allowed or allowable in earlieryears. Figuring the cost depletion deduction.Once you have figured your property's basis for depletion, thetotal recoverable units, and the number of units sold during the taxyear, you can figure your cost depletion deduction by taking thefollowing steps. Step Action Result 1 Divide your property'sbasis for depletion bytotal recoverable units. Rate per unit. 2 Multiply the rate perunit by units soldduring the tax year. Mamaia verbilligte HotelsCost depletion deduction. Percentage Depletion To figure percentage depletion, you multiply a certain percentage,specified for each mineral, by your gross income from the propertyduring the tax year. Gross income.When figuring your percentage depletion, subtract from your grossincome from the property the following amounts. Any rents or royalties you pay or incur for theproperty. The part of any bonus you paid for a lease on the propertythat is allocable to the product sold (or that otherwise gives rise togross income) for the tax year. A bonus payment includes a bonus for either a mineral lease oran oil and gas lease. Use the following fraction to figure the part of the bonus you mustsubtract. Number of units sold in the tax yearRecoverable units from the property Bonus Payments Taxable income limit.The percentage depletion deduction cannot be more than 50%(100% for oil and gas property) of your taxable income from theproperty figured without the depletion deduction. Caution: For tax years beginning after 1997 and before 2000, percentagedepletion on the marginal production of oil or natural gas is notlimited to taxable income from the property figured without thedepletion deduction. When figuring your taxable income from the property for purposes ofthe taxable income limit consider the following rules. Do not deduct any net operating loss deduction from thegross income from the property. Corporations do not deduct charitable contributions from thegross income from the property. If, during the year, you dispose of an item of section 1245property which was used in connection with mineral property, reduceany allowable deduction for mining expenses by the part of any gainyou must report as ordinary income that is allocable to the mineralproperty. See section 1.613-5(b)(1) of the regulations forinformation on how to determine the amount of ordinary gain allocableto the property. Oil and Gas Wells Generally, only small producers and royalty owners can claimpercentage depletion for any oil or gas well. However, if you arenot a small producer or royalty owner, you may be able toclaim percentage depletion for the following items. Natural gas sold under a fixed contract. Natural gas from geopressured brine. For information on the depletion deduction for these items, seeNatural Gas Wells, later. Small Producers If you are a small producer, you figure percentage depletion usinga rate of 15% of the gross income from the property based onyour average daily production of domestic crude oil or domesticnatural gas up to your depletable oil or natural gas quantity.However, certain refiners and retailers, as explained next, cannotclaim percentage depletion. For information on figuring the deduction,see Figuring percentage depletion later. Refiners who cannot claim percentage depletion.You cannot claim percentage depletion if you or a related personrefine crude oil and you and the related person refined more than50,000 barrels on any day during the tax year. Related person.You and another person are related persons if either of you holds asignificant ownership interest in the other person or if a thirdperson holds a significant ownership interest in both of you. For example, a corporation, partnership, estate, or trust andanyone who holds a significant ownership interest in it are relatedpersons. A partnership and a trust are related persons if one personholds a significant ownership interest in each of them. For purposes of the related person rules, significant ownershipinterest means direct or indirect ownership of 5% or more ofany one of the following interests. The value of the outstanding stock of a corporation. The interest in the profits or capital of apartnership. The beneficial interests in an estate or trust. Any interest owned by or for a corporation, partnership, trust, orestate is considered to be owned directly both by itself andproportionately by its shareholders, partners, or beneficiaries. Retailers who cannot claim percentage depletion.You cannot claim percentage depletion if both of the followingapply. You sell oil or natural gas or their by-products directly orthrough a related person in any of the following situations. Through a retail outlet operated by you or a relatedperson. To any person who is required under an agreement with you ora related person to use a trademark, trade name, or service mark orname owned by you or a related person in marketing or distributingoil, natural gas, or their by-products. To any person given authority under an agreement with you ora related person to occupy any retail outlet owned, leased, orcontrolled by you or a related person. The combined gross receipts from sales (not countingresales) of oil, natural gas, or their by-products of all retailoutlets taken into account in (1) are more than $5 million for the taxyear. For the purpose of determining if this rule applies, do not countthe following. Bulk sales of oil or natural gas to commercial or industrialusers. Milan hotelsBulk sales of aviation fuels to the Department ofDefense. Sales of oil or natural gas or their by-products outside theUnited States if none of your domestic production or that of a relatedperson is exported during the tax year or the prior tax year. Sales through a related person.You are considered to be selling through a related person if anysale by the related person produces gross income from which you maybenefit because of your direct or indirect ownership interest in theperson. You are not considered to be selling through a relatedperson who is a retailer if all of the following apply. You do not have a significant ownership interest in theretailer. You sell your production to persons who are not related toeither you or the retailer. ERROR MSGThe retailer does not buy oil or natural gas from yourcustomers or persons related to your customers. There are no arrangements for the retailer to acquire oil ornatural gas you produced for resale or made available for purchase bythe retailer. Neither you nor the retailer knows of or controls the finaldisposition of the oil or natural gas you sold or the original sourceof the petroleum products the retailer acquired for resale. Transfers.You cannot claim percentage depletion if you received your interestin a proven oil or gas property by transfer after 1974 and beforeOctober 12, 1990. For a definition of the term "transfer," seesection 1.613A-7(n) of the regulations. Figuring percentage depletion.Generally, as a small producer you figure your percentage depletionby computing your average daily production of domestic oil or gas andcomparing it to your depletable oil or gas quantity. If your averagedaily production does not exceed your depletable oil or gas quantity,you figure your percentage depletion by multiplying the gross incomefrom the oil or gas property by 15%. If your average daily productionof domestic oil or gas exceeds your depletable oil or gas quantity,you must make an allocation as explained later under Averagedaily production exceeds depletable quantities. In addition, there is a limit on the percentage depletiondeduction. See Taxable income limit, later. Average daily production.Figure your average daily production by dividing your totaldomestic production for the tax year by the number of days in your taxyear. Part interest.If you have a part interest in the production from a property,figure your share of the production by multiplying total productionfrom the property by your percentage of interest in the revenues fromthe property. You have a part interest in property, for example, if you have anet profits interest. To figure the share of production for your netprofits interest, you must determine your percentage participation (asmeasured by the net profits) in the gross revenue from the property.To figure this percentage, you divide the income you receive for yournet profits interest by the gross revenue from the property. Example.John Oak owns oil property in which Paul Elm owns a 20% net profitsinterest. During the year, the property produced 10,000 barrels ofoil, which John sold for $200,000. John had expenses of $90,000attributable to the property. The property generated a net profit of$110,000. Paul received income of $22,000 ($110,000 .20) forhis net profits interest. Paul determined his percentage participation to be 11% by dividing$22,000 (the income he received) by $200,000 (the gross revenue fromthe property). Paul determined his share of the oil production to be1,100 barrels (10,000 barrels 11%). Depletable oil or natural gas quantity.Generally, your depletable oil quantity is 1,000 barrels and yourdepletable natural gas quantity is 6,000 cubic feet multiplied by thenumber of barrels of your depletable oil quantity that you choose toapply. If you claim depletion on both oil and natural gas, you mustreduce your depletable oil quantity by the number of barrels you useto figure your depletable natural gas quantity. If you are involved inmarginal production, see section 613A(c) of the Internal Revenue Codeto figure your depletable oil or natural gas quantity. You must allocate the depletable oil or gas quantity among thefollowing in proportion to each entity's or family member's productionof domestic oil or gas for the year. Corporations, trusts, and estates if 50% or more of thebeneficial interest is owned by the same or related persons(considering only persons that own at least 5% of the beneficialinterest). You and your spouse and minor children. For purposes of this allocation, a related person is anyonementioned under Related person in chapter 15except thatitem (1) in that discussion includes only an individual, his or herspouse, and minor children. Members of the same controlled group of corporations are treated asone taxpayer when figuring the depletable oil or natural gas quantity.They share the depletable quantity, and one member's share of thegroup's depletable quantity will reduce the other members' share ofthe group's depletable quantity. Under this rule, a controlled groupof corporations is defined in section 1563(a), except that "morethan 50%" is substituted for "at least 80%" in thatdefinition. Gross income from oil and gas property.For purposes of percentage depletion, gross income from oil and gasproperty is the amount you receive from the sale of the oil or gas inthe immediate vicinity of the well. If you do not sell the oil or gason the property, but manufacture or convert it into a refined productbefore sale or transport it before sale, the gross income from theproperty is the representative market or field price (RMFP) of the oilor gas, before conversion or transportation. If you sold gas after you removed it from the premises, for a pricethat is lower than the RMFP, determine gross income from the propertyfor percentage depletion purposes without regard to the RMFP. Gross income from the property does not include lease bonuses,advance royalties, or other amounts payable without regard toproduction from the property. Average daily production exceeds depletable quantities.If your average daily production for the year is more than yourdepletable oil or natural gas quantity, figure your allowance fordepletion for each domestic oil or natural gas property asfollows. Figure your average daily production of oil or natural gasfor the year. Figure your depletable oil or natural gas quantity for theyear. Figure depletion for all oil or natural gas produced fromthe property using a percentage depletion rate of 15%. Multiply the result figured in (3) by a fraction, thenumerator of which is the result figured in (2) and the denominator ofwhich is the result figured in (1). This is your depletion allowancefor that property for the year. Taxable income limit.If you are a small producer of oil and gas, your deduction forpercentage depletion is limited to the smaller of the following. Your taxable income from the property figured without thededuction for depletion. 65% of your taxable income from all sources, figured withoutthe depletion allowance, any net operating loss carryback, and anycapital loss carryback. You can carry over to the following year any amount you cannotdeduct because of the 65% (of taxable income) limit. Add it to yourdepletion allowance (before applying any limits) for the followingyear. Temporary suspension of taxable income limit for marginalproduction.For tax years beginning after 1997 and before 2000, percentagedepletion on the marginal production of oil or natural gas is notlimited to taxable income from the property figured without thedepletion deduction. For information on marginal production, seesection 613A(c)(6) of the Internal Revenue Code. Partnerships and S Corporations Generally, each partner or shareholder, and not the partnership orS corporation, figures the depletion allowance separately. (However,see Electing large partnerships must figure depletion allowance,later.) Each partner or shareholder must decide whether to use cost orpercentage depletion. If a partner or shareholder uses percentagedepletion, he or she must apply the 65% of taxable income limit to hisor her taxable income from all sources. Partner's or shareholder's adjusted basis.The partnership or S corporation must allocate to each partner hisor her share of the adjusted basis of each oil or gas property held bythe partnership or S corporation. The partnership or S corporationmakes the allocation as of the date it acquires the oil or gasproperty. The partner's share of the adjusted basis of the oil or gasproperty generally is figured according to that partner's interest inpartnership capital. However, in some cases, it is figured accordingto the partner's interest in partnership income. The partnership or S corporation adjusts the partner's orshareholder's share of the adjusted basis of the oil and gas propertyfor any capital expenditures made for the property and for any changein partnership or S corporation interests. Files: Each partner or shareholder must separately keep records of his orher share of the adjusted basis in each oil and gas property of thepartnership or S corporation. The partner or shareholder must reducehis or her adjusted basis by the depletion he or she takes on theproperty each year. The partner or shareholder must use that reducedadjusted basis to figure cost depletion or his or her gain or loss ifthe partnership or S corporation disposes of the property. Reporting the deduction.Deduct oil and gas depletion for a partnership or S corporationinterest on Schedule E (Form 1040). The instructions for Schedule Eexplain where to report your income and deductions and whether youneed to file either of the following forms. Form 6198, At-Risk Limitations. Form 8582, Passive Activity LossLimitations. Electing large partnerships must figure depletion allowance.For partnership tax years beginning after 1997, an electing largepartnership, rather than each partner, generally must figure thedepletion allowance. The partnership figures the depletion allowancewithout taking into account the limits on the amount of production andtaxable income. Also, the adjusted basis of a partner's interest inthe partnership is not affected by the depletion allowance. An electing large partnership is one that meets both the followingrequirements. The partnership had 100 or more partners in the precedingyear. The partnership chooses to be an electing largepartnership. Disqualified partners.An electing large partnership does not figure the depletionallowance of its disqualified partners. The disqualified partners mustfigure it themselves, as explained earlier. All of the following are disqualified partners. Refiners who cannot claim percentage depletion (discussedunder Small Producers, earlier). Retailers who cannot claim percentage depletion (discussedunder Small Producers, earlier). Any partner whose average daily production of domestic crudeoil and natural gas is more than 500 barrels during the tax year inwhich the partnership tax year ends. Average daily production isdiscussed earlier. Natural Gas Wells You can use percentage depletion for natural gas sold under a fixedcontract or produced from geopressured brine. Natural gas sold under a fixed contract.Natural gas sold under a fixed contract qualifies for a percentagedepletion rate of 22%. Natural gas sold under a fixed contract isdomestic natural gas sold by the producer under a contract providedthat the price cannot be adjusted to reflect any increase in theseller's tax liability because of the repeal of percentage depletionfor gas. The contract must have been in effect from February 1, 1975,until the date of sale of the gas. Price increases after February 1,1975, are presumed to take the increase in tax liability into accountunless demonstrated otherwise by clear and convincing evidence. Natural gas from geopressured brine.Qualified natural gas from geopressured brine is eligible for apercentage depletion rate of 10%. Qualified natural gas fromgeopressured brine is natural gas produced from a well you began todrill after September 1978 and before 1984 determined in accordancewith section 503 of the Natural Gas Policy Act of 1978 to be producedfrom geopressured brine. Mines andGeothermal Deposits Certain mines, wells, and other natural deposits, includinggeothermal deposits, qualify for percentage depletion. Mines and other natural deposits.The percentage of your gross income from a natural deposit that youcan deduct as depletion depends on the type of deposit. The following is a list of the depletion percentages for the morecommon minerals. DEPOSITS PERCENT Sulphur, uranium, and, if from deposits in theUnited States, asbestos, lead ore, zinc ore, nickel ore, and mica 22 Gold, silver, copper, iron ore, and certain oilshale, if from deposits in the United States 15 Borax, granite, limestone, marble, mollusk shells,potash, slate, soapstone, and carbon dioxide produced from a well 14 Coal, lignite, and sodium chloride 10 Clay and shale used or sold for use in makingsewer pipe or bricks or used or sold for use as sintered or burnedlightweight aggregates 7 1/2 Clay used or sold for use in making drainageand roofing tile, flower pots, and kindred products, and gravel, sand,and stone (other than stone used or sold for use by a mine owner oroperator as dimension or ornamental stone) 5 You can find a complete list of deposits and their percentagedepletion rates in section 613(b) of the Internal Revenue Code. Corporate deduction for iron ore and coal.The percentage depletion deduction of a corporation for iron oreand coal (including lignite) is reduced by 20% of: The percentage depletion deduction for the tax year (figuredwithout regard to this reduction), minus The adjusted basis of the property at the close of the taxyear (figured without the depletion deduction for the taxyear). Gross income from mining.For property other than a geothermal deposit or an oil or gas well,gross income from the property means the gross income from mining.Mining includes all of the following. Extracting ores or minerals from the ground. Applying certain treatment processes. Transporting ores or minerals (generally, not more than 50miles) from the point of extraction to the plants or mills in whichthe treatment processes are applied. Excise tax.Gross income from mining includes the separately stated excise taxreceived by a mine operator from the sale of coal to compensate theoperator for excise tax the mine operator must pay to finance blacklung benefits. Extraction.Extracting ores or minerals from the ground includes extraction bymine owners or operators of ores or minerals from the waste or residueof prior mining. This does not apply to extraction from waste orresidue of prior mining by the purchaser of the waste or residue orthe purchaser of the rights to extract ores or minerals from the wasteor residue. Treatment processes.The processes that are included as mining depend on the ore ormineral mined. To qualify as mining, the treatment processes must beapplied by the mine owner or operator. For a listing of treatmentprocesses considered as mining, see section 613(c)(4) of the InternalRevenue Code and the related regulations. Transportation of more than 50 miles.If the IRS finds that the ore or mineral must be transported morethan 50 miles to plants or mills to be treated because of physical andother requirements, the additional transportation that is authorizedis included in the computation of gross income from mining. Envelope: If you wish to include transportation of more than 50 miles in thecomputation of gross income from mining, file an application induplicate with the IRS. Include on the application the factsconcerning the physical and other requirements which prevented theconstruction and operation of the plant within 50 miles of the pointof extraction. Send this application to: Internal Revenue Service Washington, DC 20224 Attention: Assistant Chief Counsel, Passthroughs and SpecialIndustries Disposal of coal or iron ore.You cannot take a depletion deduction on coal (including lignite)or iron ore mined in the United States that you disposed of afterholding it for more than 1 year if you retained an economic interestin it. Treat any gain on the disposition as a capital gain. Disposal to related person.This rule does not apply if you dispose of the coal or iron ore toone of the following persons. A related person (as listed in chapter 15). A person owned or controlled by the same interests that ownor control you. Geothermal deposits.Geothermal deposits located in the United States or its possessionsqualify for a percentage depletion rate of 15%. A geothermal depositis a geothermal reservoir of natural heat stored in rocks or in awatery liquid or vapor. For percentage depletion purposes, ageothermal deposit is not considered a gas well. Figure gross income from a geothermal steam well in the same way asfor oil and gas wells. See Gross income from oil and gasproperty, earlier, under ERROR MSGOil and Gas Wells. Lessor's Gross Income A lessor's gross income from the property that qualifies forpercentage depletion usually is the total of the royalties receivedfrom the lease. However, for purposes of oil, gas, or geothermalproperty, gross income does not include lease bonuses, advancedroyalties, or other amounts payable without regard to production fromthe property. Bonuses and advanced royalties.Bonuses received upon the grant of rights and advanced royaltiesare payments a lessee makes to a lessor for the lease or for minerals,gas, or oil to be extracted from leased property. Both types ofpayments are made before production. If you are the lessor, yourincome from bonuses and advanced royalties is subject to an allowancefor depletion. Figuring cost or percentage depletion on bonuses and advancedroyalties.To figure cost depletion on a bonus, multiply your adjusted basisin the property by a fraction, the numerator of which is the bonus andthe denominator of which is the total bonus and royalties expected tobe received. To figure cost depletion on advanced royalties, use thecomputation explained earlier under Cost Depletion,treating the units for which the advanced royalty is received asthe units sold. To figure percentage depletion (for other than gas, oil, orgeothermal property), any bonus or advanced royalty payments are partof your gross income from the property. Terminating the lease.If you receive a bonus on a lease that expires, terminates, or isabandoned before you derive any income from the extraction of mineralor cutting of timber, include in income the depletion deduction youtook. Also increase your adjusted basis in the property to restore thedepletion deduction you previously subtracted. For advanced royalties, include in income the depletion claimed onminerals for which the advanced royalties were paid if the mineralswere not produced before lease termination. Increase your adjustedbasis in the property by the amount you include in income. Delay rentals.These are payments for deferring development of the property. Sincedelay rentals are ordinary rent, they are ordinary income that is notsubject to depletion. These rentals can be avoided by eitherabandoning the lease, beginning development operations, or obtainingproduction.