There are two methods of depletion. Cost depletion and Percentage depletion. Below is an excerpt from Pub 535. See the link for a detailed explanation. https://www.irs.gov/pub/irs-pdf/p535.pdf
Mineral Property
Mineral property includes oil and gas wells,
mines, and other natural deposits (including geothermal
deposits). For this purpose, the term
“property” means each separate interest you
own in each mineral deposit in each separate
tract or parcel of land. You can treat two or
more separate interests as one property or as
separate properties. See section 614 and the
related regulations for rules on how to treat separate
mineral interests.
There are two ways of figuring depletion on
mineral property.
Generally, you must use the method that gives
you the larger deduction. However, unless you
are an independent producer or royalty owner,
you generally cannot use percentage depletion
for oil and gas wells. See Oil and Gas Wells,
later.
Cost Depletion
To figure cost depletion, you must first determine
the following.
The property's basis for depletion.
The total recoverable units of mineral in the
property's natural deposit.
The number of units of mineral sold during
the tax year.
Basis for depletion. To figure the property's
basis for depletion, subtract all the following
from the property's adjusted basis.
- 1. Amounts recoverable through:
- a. Depreciation deductions,
- b. Deferred expenses (including deferred
exploration
- c. Deductions other than depletion.
- 2. The residual value of land and improvements
at the end of operations.
- 3. The cost or value of land acquired for purposes
other than mineral production.
Oil and Gas Wells
You cannot claim percentage depletion for an
oil or gas well unless at least one of the following
applies.
You are either an independent producer or
a royalty owner.
The well produces natural gas that is either
sold under a fixed contract or produced
from geopressured brine.
If you are an independent producer or royalty
owner, see Independent Producers and
Royalty Owners next.
For information on the depletion deduction
for wells that produce natural gas that is either
sold under a fixed contract or produced from
geopressured brine, see Natural Gas Wells,
later.
