The oil depletion allowance in American (US) tax law is an allowance claimable by anyone with an economic interest in a mineral deposit or standing timber. The principle is that the asset is a capital investment that is a wasting asset, and therefore depreciation can reasonably be offset (effectively as a capital loss) against income.
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The oil depletion allowance has been subject of interest, because of the relationship of big oil with the US government, and because one of the two methods of claiming the allowance makes it possible to write off more than the whole capital cost of the asset.
Depletion calculation
Two methods of depletion calculations are available, detailed regulations determine which can be used, but in some circumstances the asset owner can choose.
Cost depletion
With this method the original investment is effectively amortized over the productive life of the asset, starting with the original capital investment, the annual percentage being the percentage of the reserves at the beginning of the year that are sold in the course of the year. The amortized amount is deducted from the net income before calculating taxes. The total amount deducted by this method cannot exceed the original value of the capital invested.
Percentage depletion
With this method, a fixed percentage of the gross income is treated as deductible. The percentage is dependent on the nature of the resource being extracted. It is possible under this scheme for the total deductibles (or indeed the annual deductible) to exceed the original capital investment.
Table of percentages
The following percentages are prescribed by the Internal Revenue Code, section 613(b).
For geothermal assets the rate is 15%
Limits
For independent producers or royalty owners of oil and gas, the deduction for percentage depletion is limited to the smaller of:
Amounts not deductible due to the 65% limit can be carried forward.