United States
Depletion Allowances
19.A75. A deduction for depletion of a natural resource (including mines and quarries) is allowed to the owner of such a resource and it is directed towards allowing recovery of the cost over the life of the resource.
19.A76. The basic method of computing depletion is known as cost depletion. Determination of cost depletion requires first an estimate of the number of units (tons, barrels) which make up the deposit. Then that part of the cost of the property which is attributable to the depleted reserves is divided by the number of units. The quotient is the cost depletion per unit. This amount, multiplied by the number of units extracted and sold during the year, determines the cost depletion deductible for the year. Each year the ‘cost basis’ of the property is reduced, but not below zero, by the amount of depletion deducted for that year, whether cost or percentage depletion was used. The remaining basis is used in computing cost depletion for the next year.
Example
Taxpayer purchases a mine for $10,000 and estimates that there are 100,000 tons of ore to be extracted. During the first year he mines 7,500 tons and sells 7,000 tons. Depletion for the first year would be computed as follows:
Rate of depletion per ton = $10,000 ÷ 100,000 = 0.10 cent
Depletion for year (0.10 cent × 7,000) = $700
The next year taxpayer sells 6,000 tons. However, a revised estimate at the end of the year indicates that there are 180,000 tons unextracted. Depletion for the second year would be computed as follows:
| Revised estimate of unextracted tonnage | 180,000 |
| Tons mined during the year | 6,000 |
| Total tonnage to be used on computing new rate | 186,000 |
| Original cost | $10,000 |
| First year's depletion | $700 |
| Remaining cost | $9,300 |
| New rate of depletion per ton = $9,300 ÷ 186,000 = | 0.5 cent |
| Depletion for year (0.5 cent × 6,000) = | $300 |
Percentage Depletion
19.A77. An alternative method of computing a deduction is available for all depletable property except timber. Under this method a flat percentage of gross income from the property is taken as the depletion deduction. The percentage depletion may not exceed 50 per cent of the taxable income from the property, computed without regard to the depletion allowance. However, if cost depletion would result in a greater deduction, it must be used. Percentage depletion ordinarily permits recovery of much more than cost and is allowed at varying percentages of gross income from the property. For example, the depletion rate is 22 per cent in the case of uranium, oil, gas and sulphur, and 15 per cent in the case of gold, silver and iron.
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Development Expenditures
19.A78 Expenditure incurred for the development of a mine or other natural deposit after the existence of minerals has been disclosed is fully deductible in the year in which incurred. Alternatively, the taxpayer may elect to treat it as deferred expenditure to be deducted rateably as and when the mineral or ore is sold. The election to defer deductions may be made for each year while the mine or deposit is in the development stage, but must be for the total amount of net development expenditure made in that year with respect to the mine.
19.A79. The normal depreciation provisions apply to improvements in the case of mines or oil and gas wells: the taxpayer may elect to employ the straight-line, fixed percentage or reducing-balance method of depreciation. In addition, the normal depreciation charges apply to all depreciable property used in drilling and development.
19.A80. It will be noted that the taxpayer's deduction for wasted capital may exceed his actual unrecovered capital cost. This arises because a large part of the capital expenditure is permitted to be deducted as incurred, and then (percentage) depletion is allowed as a percentage of receipts without regard to the remaining unrecovered capital expenditure.