Depletion is one of the most beneficial tax deductions and strategies for an oil and gas investor. The term depletion refers to tax write offs. According to the oil and gas accounting rules, an individual must capitalize all the costs incurred to attain, discover and develop the properties for oil and gas production. These costs are usually referred to as capitalized leasehold costs.
Leasehold costs include amounts paid in connection with the procurement of a gas and oil lease, such as:
Some geophysical and geological costs
When property is obtained as the consequence of a drilling commitment that reimburses for drilling costs before its decline, no capitalization of the attributed leasehold value is usually required. These leasehold capital costs stay with the original property owner.
Understanding the differences between the various depletion opportunities available is vital to ensure that each property utilizes the depletion method offering the most benefit to its owner.
Kinds of Depletion – Cost, Book and Percentage
The amount an oil and gas investor can deduct for depletion is determined on a property to property basis. Only investors who hold economic interests can deduct the depletion amount on a property.
Leasehold costs that are acquired in connection with procurement of gas and oil property can be capitalized and recovered using the depletion deductions available through:
The producing life of each property
As an offset, by the amount realized when the property is sold or exchanged
In the year a property is determined as worthle...
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...re not permitted to take a percentage depletion deduction.
Quantity Limitation Rate
The quantity limitation rate must be determined if the average daily production exceeds 1,000 barrels of oil or 6,000 mcf of natural gas. By determining the quantity limitation rate, investors can choose to split their depletion claim between oil and gas production.
Average daily oil production - 1,200 barrels (only 1,000 allowed)
Average daily gas production - 6.2 mcf (only 6,000 allowed)
The investor may choose to claim depletion for 500 barrels of oil and 3 mcf of gas a day (6000 cubic feet depletable gas quantity x 500 barrels of oil = 3 mcf ).
Oil and gas investors should take the time understand the differences between Cost, Book and Percentage Tax Depletion so as to determine which tax write offs will benefit them the most with the oil prices today.
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