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:: Placer Mining Industry - Chapter 8 - Deletion
Depletion,
like
depreciation,
is a
form of
cost
recovery.
Just as
the
owner of
a
business
asset is
allowed
to
recover
the cost
of an
asset
over its
useful
life, a
miner is
allowed
to
recover
the cost
of
mineral
property.
Depletion
is taken
over the
period
of time
that
mineral
is being
extracted.
Two
forms of
depletion
are
allowed:
cost
depletion
and
percentage
depletion.
The
taxpayer
is
required
to use
the
method
which
will
result
in the
greatest
deduction.
Cost
Depletion
The
general
method
used for
the
calculation
of
depletion
is the
cost
method.
The
first
step of
this
method
is to
determine
the
number
of units
which
comprise
the
deposit.
The
units
can be
tons of
ore,
barrels
of oil,
board
feet of
timber,
etc. The
taxpayer
must be
consistent
from
year to
year in
the type
of unit
being
calculated
to
insure
uniformity.
The
second
step
takes
the cost
or
adjusted
basis of
the
property
which
pertains
to the
deposit
and
divides
this
basis by
the
total
number
of units
to
obtain
the
depletion
cost per
unit.
Once the
total
number
of units
extracted
is
determined
for the
tax
year, it
is
multiplied
by the
cost per
unit to
obtain
the
amount
of
depletion
available.
It is
possible
that
during
the
course
of the
operation
or from
examination,
the
estimate
of the
number
of units
which
comprise
the
deposit
may
change.
If this
happens,
the
calculation
can
change.
While
the
number
of units
can be
recalculated,
the
basis
cannot
be
adjusted.
It is
advisable
to
discuss
with the
taxpayer
as early
as
possible
how they
estimated
the
number
of units
used in
the
depletion
calculation.
It is
also
helpful
to
determine
if the
taxpayer
has
adjusted
this
estimate
over the
course
of
production.
Check to
see if
the
taxpayer
is being
consistent
with the
measure
of units
and what
method
was used
to
develop
the new
estimate.
The
following
example
covers
depletion
using
constant
estimates.
The
taxpayer
purchases
a claim
for
$50,000,
with
known
mineral
reserves
in
mineable
quantities.
He
states
that he
is in
the
production
phase
and is
selling
product.
The
taxpayer
estimates
that
there is
100,000
tons of
ore to
be
extracted.
For
purposes
of the
computation
for
depletion,
the
basis of
the mine
is
$50,000.
During
the tax
year,
the
taxpayer
mines
and
sells
3,500
tons of
ore. The
first
year
depletion
would be
calculated
as
follows:
Rate of
Depletion
per ton
($50,000/100,000)
$
.50
Depletion for year (3,500 x $.50)
$
1,750.00
Purchase price
$
50,000
First year depletion
1,750
--------
First year basis of the property
$
48,250
If
estimates
of the
amount
of
reserves
were
never
adjusted,
the
above
calculation
for
depletion
would
remain
constant.
The
basis
would be
reduced
each
year by
the
amount
of
depletion
until it
is
totally
consumed
and the
taxpayer
has no
basis
left in
the
property.
At this
time,
cost
depletion
is no
longer
allowed.
While
this
scenario
would
certainly
not be
out of
the
ordinary,
a
revision
in the
estimate
of
reserves
will
affect
the
depletion
calculation,
and
should
be
thoroughly
examined.
The
following
example
covers
depletion
using
revised
estimates.
In tax
year 2,
the
miner
sells
7,000
tons. At
the end
of the
year,
the
estimate
of the
ore
changes
to
130,000
tons.
The
calculation
for
depletion
for year
2 would
be as
follows:
Revised
estimate
of
unextracted
ore
130,000
Ore sold during the year
7,000
-------
Total tonnage used to compute new rate
137,000
Remaining Adjusted Basis of property
$48,250
Rate of Depletion per ton ($48,250 / 137,000) $
.35
Depletion for year 2 (7,000 x .35)
$ 2,450
First year basis of the property
$48,250
Second year depletion
-2,450
-------
Second year basis of the property
$45,800
Percentage
Depletion
Under
the
percentage
depletion
method,
a flat
percentage
of gross
income
from the
activity
is used
to
calculate
the
depletion
allowance.
The
deduction
for
depletion
cannot
exceed
50
percent
of the
taxable
income
from the
activity.
This
limitation
is
computed
without
regard
to the
depletion
allowance.
Depletion
percentages
are
found in
IRC
section
613(b)
and
Treas.
Reg.
section
1.613-2.
The
amount
of the
deduction
allowable
under
percentage
depletion
is not
limited
by the
basis of
the
property.
Thus,
even
though
the
basis of
the
property
is
reduced
by the
amount
of
depletion
taken,
if the
basis
becomes
zero,
the
depletion
based on
the
percentage
of gross
income
may
continue.
However,
if cost
depletion
will
yield a
higher
deduction,
it must
be used
to
calculate
the
amount
deducted.
In using
percentage
depletion
the
concepts
of gross
income,
taxable
income,
and
different
percentages
based on
the type
of
material
extracted
all come
into
play in
the
computation.
The Code
and
Regulations
are
specific
regarding
the
percentages
to be
used for
the
various
types of
materials
which
can be
mined.
Particular
attention
should
be paid
to the
type of
arrangement
the
taxpayer
is
involved
in, that
is, is
the
property
being
leased,
are
there
royalties
involved,
are
there
prepayments
of any
kind,
etc.
This
information
should
be
discussed
in the
initial
interview
in order
to
clearly
establish
the
nature
of the
mining
activity.
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