Depletion is the allowance for the exhaustion of a natural resource, a mine, an oil or gas well, another mineral deposit or standing timber, taken as the units in it are extracted or sold. It is both a charge on the books and a deduction on a US return. Tax law computes the deduction two ways, and the same property can be eligible for both: cost depletion spreads the property’s adjusted basis over the units expected to be recovered from it, and percentage depletion applies a statutory rate to the gross income the property produces.
The statute that allows the deduction names the assets it reaches. In the case of mines, oil and gas wells, other natural deposits, and timber, there shall be allowed as a deduction in computing taxable income a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case (26 U.S.C. 611(a)).
Depreciation and amortization are the same kind of charge for other assets, allocations of money already spent rather than payments made in the period, and both are defined in EBITDA. What sets depletion apart is that the charge follows units removed from a finite deposit rather than time elapsed, and that one of its two methods is a statutory allowance rather than an allocation of cost at all.
Cost Depletion, Basis Divided by Units
Cost depletion is the method built out of the property’s own cost, so it runs like depreciation in structure and differs only in what it divides by. The basis it starts from is the adjusted basis provided in section 1011 for determining gain on a sale or other disposition of the property (26 U.S.C. 612).
The regulation states the arithmetic. Cost depletion for the year is computed by dividing that basis by the number of units of mineral remaining as of the taxable year, then multiplying the depletion unit so determined by the number of units of mineral sold within the taxable year (26 CFR 1.611-2(a)(1)).
Both counts are defined terms rather than everyday ones. Units remaining as of the taxable year means the units left at the end of the year to be recovered from the property, including units recovered but not sold, plus the units sold within the year. Units sold follows the taxpayer’s own method of accounting, so a cash-basis taxpayer counts units paid for during the year and an accrual taxpayer works from inventories kept in physical quantities (26 CFR 1.611-2(a)(2) and (a)(3)).
Cost depletion stops at basis. No further deduction for cost depletion is allowed once the sum of the credits for depletion equals the cost or other basis of the property plus allowable capital additions (26 CFR 1.611-2(b)(2)).
Percentage Depletion, a Rate on Gross Income
Percentage depletion ignores basis. It is a specified percentage of the gross income from the property, excluding from that gross income an amount equal to any rents or royalties the taxpayer paid or incurred on the property (26 U.S.C. 613(a)).
Gross income from the property is a defined term, not sales revenue. For a property other than an oil or gas well or a geothermal deposit it means the gross income from mining, and mining reaches the extraction of the ore or mineral, the treatment processes the statute lists as mining, and so much of the transportation from the point of extraction to the plant where those processes are applied as is not in excess of 50 miles, unless the Secretary finds the mineral must be carried further (26 U.S.C. 613(c)(1) and (c)(2)). Value a client adds after that cut-off sits outside the base.
The rate is set by the mineral, not by the taxpayer. Sulphur and uranium sit at 22 percent. Gold, silver, copper and iron ore from deposits in the United States are at 15 percent, coal is at 10 percent, and gravel, sand and pumice are at 5 percent (26 U.S.C. 613(b)).
A ceiling tied to the property’s own taxable income sits on top of the rate. The allowance may not exceed 50 percent of the taxpayer’s taxable income from the property, computed without the allowance for depletion and without any deduction under section 199A, and that ceiling is 100 percent in the case of oil and gas properties (26 U.S.C. 613(a)).
The percentage method also cannot leave a property worse off than it would be without it. In no case is the allowance for depletion under section 611 less than it would be if computed without reference to section 613 (26 U.S.C. 613(a)), so a property eligible for both methods takes whichever figure is larger.
That is why percentage depletion can outrun the money actually spent on the deposit. Once the credits for depletion have equalled basis and cost depletion has stopped, depletion deductions may still be allowable computed on a percentage of gross income from the property (26 CFR 1.611-2(b)(2)).
Oil and gas is carved out of the percentage method and then partly carved back in. The allowance for any oil or gas well is generally computed without regard to section 613 at all (26 U.S.C. 613A(a)). Independent producers and royalty owners get it back at 15 percent, on average daily production up to the taxpayer’s depletable oil quantity, for which the tentative quantity is 1,000 barrels (26 U.S.C. 613A(c)). That deduction is then held to 65 percent of the taxpayer’s taxable income for the year, computed without that depletion and without the carrybacks and other items the subsection lists (26 U.S.C. 613A(d)(1)).
A Worked Example
Say a client capitalizes the cost of a gravel deposit, estimates the tons still recoverable from it, and sells part of that tonnage during the year at a stated price a ton. Take the gravel as sold at the mining cut-off, with no further processing and no haul past the statutory distance, so the price a ton is also the gross income from mining. On those inputs the two methods produce this.
Capitalized basis in the deposit 1,200,000
Recoverable tons, including the year's sales 400,000
Depletion unit per ton 3.00
Tons sold during the year 50,000
Cost depletion 150,000
Price a ton 12.00
Gross income from the property 600,000
Percentage depletion at the gravel rate 30,000
Taxable income from the property, before depletion 250,000
The ceiling on percentage depletion 125,000
Allowance taken, the larger of the two methods 150,000The ceiling never binds here, because the percentage figure lands well beneath it. The larger of the two methods wins, so this property takes cost depletion and the smaller percentage figure is not used. Run the same deposit late in its life, after basis has been drawn down and prices have risen, and the two figures can swap places.
Where Depletion Reaches a Return
Depletion does not travel on Form 4562, which is titled Depreciation and Amortization and carries no depletion line at all (IRS, Form 4562, 2025).
Each return type has its own line instead. A sole proprietor enters the deduction on Schedule C at line 12, Depletion (IRS, Schedule C (Form 1040), 2025). Rental real estate and royalty activity shares one line with depreciation on Schedule E, at line 18, Depreciation expense or depletion (IRS, Schedule E (Form 1040), 2025).
A C corporation has a line of its own, line 21, Depletion (IRS, Form 1120, 2025). A partnership uses line 17, and the caption printed on the line itself tells the preparer not to deduct oil and gas depletion there (IRS, Form 1065, 2025).
Timber gets a schedule rather than a line. Form T (Timber), Forest Activities Schedule, provides information on timber accounts when a sale or deemed sale under sections 631(a), 631(b), or another exchange has occurred during the tax year, and Part II of it is where timber depletion is figured (IRS, Instructions for Form T (Timber)). A proprietor with timber depletion is told to attach that form to the Schedule C (IRS, Instructions for Schedule C (Form 1040), 2025).
Depletion does not stop at the deduction line either. It is generally an item of tax preference under the alternative minimum tax (IRS, Instructions for Schedule C (Form 1040), 2025), measured as the excess of the deduction allowable under section 611 for the year over the property’s adjusted basis at the end of the year, and that preference does not reach depletion computed in accordance with section 613A(c) (26 U.S.C. 57(a)(1)).
What Sits in the Client’s Records
None of the inputs reach the return, so the schedule behind the number is the only place a reviewer can test it. A taxpayer claiming depletion on mineral property keeps a separate account accurately recording the cost or other basis of the property, later allowable capital additions and the other adjustments required by section 1016, credited annually with the depletion computed (26 CFR 1.611-2(b)(1) and (b)(2)). Timber carries the same duty in plainer words: a depletion schedule is required to be maintained for all types of timber ownership (IRS, Instructions for Form T (Timber), Part II).
The recoverable-units estimate is the input that moves. Where operations or development work show that the recoverable units are greater or less than the prior estimate, the estimate is revised but the basis for depletion is not, and the allowance for subsequent taxable years is based on the revised estimate (26 U.S.C. 611(a)). The regulation is more specific about when the new figure starts to bite: the revised estimate carries the cost depletion allowance for the taxable year it is ascertained in and for every subsequent year, until a change in the facts requires another revision (26 CFR 1.611-2(c)(2)). A reserve re-estimate therefore reaches the year in hand as well as the years after it, and leaves the years already filed alone.
On the books the accumulated charge sits beside the asset rather than being folded into it, the contra-account structure set out in debit versus credit. The federal standard account list carries the depletion pair directly: Other Natural Resources at account 184000 with a debit normal balance, and Allowance for Depletion at account 184900 with a credit one, recording the reduction of an estimated available quantity (Treasury Financial Manual, USSGL Part 1 Section II, Accounts and Definitions, fiscal 2026).
Where the deposit is leased rather than owned outright, the deduction is equitably apportioned between the lessor and the lessee (26 U.S.C. 611(b)(1)).
Depletion, Depreciation and Amortization
Depletion attaches to a finite natural deposit and tracks the units taken out of it, which is why its charge per unit is revised whenever the estimate of what is left changes.
The pairing that catches people is inside depletion itself. Cost depletion and percentage depletion are not two names for one number. On the same property in the same year they usually produce different figures, only one of them is limited by remaining basis, and the charge a firm records on the books can therefore sit some distance from the deduction that reaches the return.
If depletion and fixed-asset schedules are the client work that slips to the end of every close at your firm, a trial task puts a block of it through Accountably’s review chain before your own reviewer relies on it.
