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Mineral Property Mineral property includes oil and gas wells, mines, and other natural deposits (including ge- othermal deposits). For this purpose, the term “property” means each separate interest you own in each mineral deposit in each separate tract or parcel of land. You can treat two or more separate interests as one property or as separate properties. See section 614 and the related regulations for rules on how to treat sep- arate mineral interests. There are two ways of figuring depletion on mineral property. • Cost depletion. • Percentage depletion. Generally, you must use the method that gives you the larger deduction. However, unless you are an independent 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 deter- mine the following. • The property's basis for depletion. • The total recoverable units of mineral in the property's natural deposit. • The number of units of mineral sold during the tax year. Basis for depletion. To figure the property's basis for depletion, subtract all the following from the property's adjusted basis. 1. Amounts recoverable through: a. Depreciation deductions, b. Deferred expenses (including defer- red exploration and development costs), and c. Deductions other than depletion. 2. The residual value of land and improve- ments at the end of operations. 3. The cost or value of land acquired for pur- poses other than mineral production. Adjusted basis. The adjusted basis of your property is your original cost or other ba- sis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Your adjusted basis can never be less than zero. See Pub. 551 for more information on adjusted ba- sis. Total recoverable units. The total recovera- ble units is the sum of the following. • The number of units of mineral remaining at the end of the year (including units re- covered but not sold). • The number of units of mineral sold during the tax year (determined under 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 mineral prod- ucts using the current industry method and the most accurate and reliable information you can obtain. You must include ores and minerals that are developed, in sight, blocked out, or as- sured. You must also include probable or pro- spective ores or minerals that are believed to exist based on good evidence. But see Elective safe harbor for owners of oil and gas property, later. Number of units sold. You determine the number of units sold during the tax year based on your method of accounting. Use the follow- ing table to make this determination. IF you use ... THEN the units sold during the year are ... the cash method of accounting the units sold for which you receive payment during the tax year (regardless of the year of sale). an accrual method of accounting the units sold based on your inventories and method of accounting for inventory. The number of units sold during the tax year does not include any for which depletion deduc- tions were allowed or allowable in earlier years. Figuring the cost depletion deduction. Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by tak- ing the following steps. Step Action Result 1 Divide your property's basis for depletion by total recoverable units. Rate per unit. 2 Multiply the rate per unit by units sold during the tax year. Cost depletion deduction. You must keep accounts for the depletion of each property and adjust these accounts each year for units sold and depletion claimed. Elective safe harbor for owners of oil and gas property. Instead of using the method de- scribed earlier to determine the total recovera- ble units, you can use an elective safe harbor. If you choose the elective safe harbor, the total recoverable units equal 105% of a property's proven reserves (both developed and undevel- oped). For details, see Revenue Procedure 2004-19 on page 563 of I.R.B. 2004-10, availa- ble at IRS.gov/irb/2004-10_IRB/RP-2004-19. To make the election, attach a statement to your timely filed (including extensions) original return for the first tax year for which the safe harbor is elected. The statement must indicate that you are electing the safe harbor provided by Revenue Procedure 2004-19. The election, if made, is effective for the tax year in which it is made and all later years. It cannot be revoked for the tax year in which it is elected, but may be revoked in a later year. Once revoked, it cannot be re-elected for the next 5 years. Percentage Depletion To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year. The rates to be used and other rules for oil and gas wells are discussed later under Inde- pendent Producers and Royalty Owners and under Natural Gas Wells. Rates and other rules for percentage depletion of other specific miner- als are found later under Mines and Geothermal Deposits. Gross income. When figuring percentage de- pletion, subtract from your gross income from the property the following amounts. • Any rents or royalties you paid or incurred for the property. • The part of any bonus you paid for a lease on the property allocable to the product sold (or that otherwise gives rise to gross income) for the tax year. A bonus payment includes amounts you paid as a lessee to satisfy a production payment re- tained by the lessor. Use the following fraction to figure the part of the bonus you must subtract. No. of units sold in the tax year Recoverable units from the property × Bonus Payments For oil and gas wells and geothermal depos- its, more information about the definition of gross income from the property is under Oil and Gas Wells, later. For other property, more infor- mation about the definition of gross income from the property is under Mines and Geother- mal Deposits, later. Taxable income limit. The percentage deple- tion deduction generally cannot be more than 50% (100% for oil and gas property) of your tax- able income from the property figured without the depletion deduction and the domestic pro- duction activities deduction. Taxable income from the property means gross income from the property minus all allow- able deductions (except any deduction for de- pletion or domestic production activities) attrib- utable to mining processes, including mining transportation. These deductible items include, but are not limited to, the following. • Operating expenses. • Certain selling expenses. • Administrative and financial overhead. • Depreciation. • Intangible drilling and development costs. • Exploration and development expendi- tures. • Deductible taxes (see chapter 5), but not taxes that you capitalize or take as a credit. • Losses sustained. The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit. • Do not deduct any NOL deduction from the gross income from the property. • Corporations do not deduct charitable con- tributions from the gross income from the property. • If, during the year, you dispose of an item of section 1245 property that was used in connection with mineral property, reduce any allowable deduction for mining expen- ses by the part of any gain you must report as ordinary income that is allocable to the Page 36 Chapter 9 Depletion