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The IRS code allows for percentage or cost depletion allowances to help owners account for the depletion of reserves during the production and sale of oil and gas.
Depletion allowance is a deduction from gross income that reflects the reduction of mineral deposits. This deduction encourages investment in oil and gas production by providing a tax incentive for the cost depletion of reserves.
Individuals or entities with an economic interest in a mineral deposit, such as natural gas reserves, can claim the oil depletion allowance. This interest exists if:
The IRS sets different depletion rates for various natural resources. Some examples include:
The depletion allowance makes investing in oil and gas wells a highly tax-favored option in the United States. Independent oil and gas producers and small investors can enjoy tax-free income of approximately 15% of their gross income from oil and gas operations.
There is no limit on the total amount that can be deducted for non-renewable resource depletion. However, percentage depletion can only be applied to oil and gas properties that generate net income. If a property incurs a net loss in a tax year, percentage depletion cannot be applied, and it is typically capped at 50% of net income.
Two methods are used to calculate the oil depletion allowance: cost depletion and percentage depletion. If net income is less than 15% of gross income, the percentage depletion deduction is limited to 100% of net income.
Under U.S. tax law, anyone with an economic interest in a mineral deposit can benefit from the oil depletion allowance. This significant subsidy provides a tax-advantaged investment opportunity for investors in the United States. The allowance varies for different natural resources, and royalty owners in oil and gas operations enjoy a taxable income limit
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Pecos Country Operating, LLC is a privately owned oil and gas exploration and production company headquartered in Fort Worth. We own and operate wells across the South Central United States with our predominant means of production coming out of West and North Texas.