Depletion Allowance
An income-tax deduction for the gradual using-up of a finite mineral reserve. Royalty owners often use percentage depletion, commonly 15%.
The depletion allowance is an income-tax deduction that recognizes minerals are a finite asset being used up as they are produced. Much like depreciation on a building, it lets a royalty or working interest owner deduct a portion of income each year to account for the reserves leaving the ground for good.
There are two methods. Cost depletion spreads your tax basis in the property across the reserves as they are produced. Percentage depletion instead deducts a fixed percentage of gross income — 15% for oil and gas, available to royalty owners and independent producers but not integrated major oil companies, and subject to a small-producer volume limit. Eligible taxpayers generally take whichever method yields the larger deduction, subject to net-income and taxable-income caps. Percentage depletion can sometimes exceed your remaining basis, which is part of why it is valuable.
This is general information, not tax advice — the rules are detailed and a CPA should run your specific numbers. Depletion works alongside your basis and the capital gains math when you eventually sell.