Depletion Allowance for Oil and Gas Overview

Wednesday, February 14th, 2024 and is filed under New Mexico Oil and Gas Investing, Oil and Gas Fun Facts, Texas Oil and Gas Investing

The depletion allowance is a tax provision in the United States designed to account for the reduction of natural resources, such as oil and gas, as they are extracted and sold. The depletion allowance for oil and gas allows businesses engaged in the extraction of these resources to recover some of their capital investment by utilizing a portion of their gross income from the sale of the resources as a tax deduction.

For the oil and gas industry, the depletion allowance functions similarly to depreciation for other types of assets. However, unlike depreciation which accounts for the reduction in value of tangible assets over time, depletion specifically accounts for the reduction in the quantity of the natural resource being extracted.

What is the depletion allowance?

The depletion allowance is a tax provision in the United States designed to account for the reduction of natural resources, such as oil and gas, as they are extracted and sold.

Oil and Gas Depletion Allowance Types

There are generally two types of depletion allowances:

1. Percentage depletion: This method allows businesses to deduct a percentage of their gross income from the sale of the extracted resource. For oil and gas, the percentage depletion rate is set at 15% of the gross income from the property, subject to certain limitations and qualifications.
2. Cost depletion: This method allows businesses to deduct the actual cost of the resource extracted from the property’s basis. This includes expenses related to exploration, development, and extraction.

Depletion Allowance Tax Benefit

The percentage depletion method is typically more favorable for smaller producers or independent operators, as it allows them to deduct a fixed percentage of gross income without regard to their actual investment in the property. On the other hand, larger producers may prefer the cost depletion method, as it allows them to recover their actual investment in the property.

The depletion allowance is an important tax benefit for the oil and gas industry as it helps to incentivize investment in the exploration and extraction of natural resources, which in turn contributes to domestic energy production and the economy.

Disclaimer

The above general discussion is provided for background information only. This information is not intended to be individual advice. Prospective participants should consult with their personal tax professional regarding the applicability and effect of any and all benefits for their own personal tax situation. In addition, tax laws change from time to time and there is no guarantee regarding the interpretation of any tax laws regarding tax-deductible investments. Oil and gas tax deductions 2023 did not change significantly from oil and gas tax deductions 2022. For more information, please visit www.irs.gov.