The depletion allowance is a federal income-tax deduction that lets oil and gas royalty owners recover the gradual exhaustion of a finite reservoir by deducting a portion of their royalty income.
Because a producing reservoir is a wasting asset, the tax code allows a depletion deduction. Percentage depletion deducts a fixed statutory percentage of gross royalty income (subject to limits and eligibility). Cost depletion recovers your tax basis in the property over the units produced. Eligible owners generally use whichever is larger, within the rules.
Depletion is one reason royalty income is taxed differently than ordinary wages. The specifics — eligibility, limits, and basis — are genuinely technical, so this is a place to work with a CPA who knows oil and gas.
Capital gains when you sell minerals
Taxes on mineral rights you own
Educational information only — not legal, tax, or investment advice. Consult a qualified attorney, CPA, or landman about your specific situation.
Owners of an economic interest in producing oil and gas — including royalty and mineral owners — generally can. Percentage depletion has eligibility limits, so confirm your situation with a tax professional.
Percentage depletion deducts a set percentage of gross income; cost depletion recovers your basis over units produced. Eligible taxpayers typically take the larger of the two, subject to limitations.
Depletion applies to production income while you own the interest. A sale is generally a capital transaction with its own tax treatment — a separate analysis your CPA should handle.
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