What is Depletion Allowance?
How Does Depletion Allowance Work?
There are two basic forms of depletion allowance, cost depletion and percentage depletion.
Cost depletion can be illustrated in this way:
An oil company invests $15 million in a property with an estimated oil reserve life of 15 years. The company deducts approximately $1,000,000 ($15 million/15 years) from taxable earnings each year until the initial investment is recouped in tax benefits.
The percentage method involves perpetually deducting a percentage from gross income earned, whereby more than the original cost can be recouped.
For example, a company might simply deduct 10% from gross income for as long as the property produces.
Why Does Depletion Allowance Matter?
In the case of certain investments such as royalty trusts, depletion is accounted for in a portion of dividend payments that are treated as return of capital, which is not taxed directly but offset against the cost basis and paid as capital gains when the security is sold.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.