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How does the oil and gas percentage depletion 65% of taxable income limit work.

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Brett Thompson, JD, CPA
Percentage depletion is not limited by the acquisition cost of the producing property as is cost depletion, and can continue year to year more than the acquisition cost. The net production in dollars is computed for each producing well by taking the revenue produced by each well and subtracting direct costs of each well. This would include production taxes, marketing and transportation costs, depreciation on well equipment on a well-by-well basis, for example. Then indirect costs must be computed and allocated on a well-by-well basis. The result is the net income from each well.

Then, for independent producers, which is most of us, you multiply GROSS production on a well-by-well basis by 15%, but that number cannot exceed the net income from each separate well. Any excess above the net income from each separate well cannot be carried forward.

Finally, the sum of all the percentage depletion for all wells cannot exceed 65% of the taxable income of the taxpayer. Any excess can be carried forward into the next year’s 65% computation.

Whatever the result, the final percentage depletion is back-allocated to the separate wells for purposes of computing cost depletion in following years.

In computing depletion for oil and gas production, the greater of cost depletion or percentage depletion may be deducted. Cost depletion is computed by multiplying the acquisition price of the leasehold (for example) subtracting depletion deducted in prior years (cost or percentage) and multiplying by a fraction. The fraction is the past production for the year divided by an estimate of the end of the year recoverable product. Cost depletion is not available once the acquisition price has been fully recovered.

Most commercial tax preparation software does not make these computations, although Lacerte might.
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