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Depletion Allowance on Natural Resource Investment
For those who own interest in oil & gas wells, mines, timber, mineral deposits or reserves, and other natural deposits the IRS provides a deductable “depletion allowance”. An easy parallel can be drawn to depreciation, the end result being a deduction due to the erosion and “cost recovery” of the asset during the course of investment. In the case of depletion there are two methods of accounting: cost and percentage basis.
Cost basis depletion involves an allowance based on the original investment. If one were to invest $5M in an oil well, the investor would be entitled to regain that capital investment. This process would take place as the oil is extracted and sold. IRS code “permits the taxpayer to divide the cost of the investment by the estimated total of recoverable units in the natural deposit. This cost per unit is subsequently multiplied by the number of units sold annually, which results in the depletion deduction permitted for that year.” This can be used for a maximum of $2M in deductions each year. The caveat with this method is that it can only be used to recoup the original cost basis.
Percentage depletion is much different in that it allows ... more
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