J.K. Lasser's Your Income Tax 2013: For Preparing Your 2012 Tax Return

9.15 Depletion Deduction

Properties subject to depletion deductions are mines, oil and gas wells, timber, and exhaustible natural deposits.

Two methods of computing depletion are: (1) cost depletion and (2) percentage depletion. If you are allowed to compute under either method, you must use the one that produces the larger deduction. In most cases, this will be percentage depletion. For timber, you must use cost depletion.

Cost depletion.

The cost depletion of minerals is computed as follows: (1) divide the total number of units (such as tons or barrels) remaining in the deposit to be mined into the adjusted basis of the property; and (2) multiply the unit rate found in Step 1 by the number of units for which payment is received during the taxable year if you are on the cash basis, or by the number of units sold if you are on the accrual basis.

Adjusted basis is the original cost of the property, less depletion allowed, whether computed under the percentage or cost depletion method. It does not include nonmineral property such as mining equipment. Adjusted basis may not be less than zero.

Timber depletion is based on the cost of timber (or other basis in the owner’s hands) and does not include any part of the cost of land. Depletion takes place when standing timber is cut. Depletion must be computed by the cost method, not by the percentage method. However, instead of claiming the cost depletion method, you may elect to treat the cutting of timber as a sale subject to capital ...