Percentage Depletion
Percentage depletion lets a qualifying mineral owner deduct a flat 15% of gross royalty income each year as a tax allowance for the reservoir being used up — and it can continue even after the property's cost basis is fully recovered.
Depletion is the oil-and-gas analog of depreciation: a yearly deduction recognizing that every barrel produced permanently uses up a finite resource. The IRS allows two methods, and an eligible owner generally takes whichever is larger each year.
Cost depletion spreads your actual cost basis in the minerals across the units produced — once the basis is recovered, the deduction stops. Percentage depletion instead deducts a statutory 15% of the gross income from the property, regardless of basis. Because it isn't tied to basis, percentage depletion can keep generating deductions for the entire producing life of the well — a meaningful advantage for long-lived royalty interests.
It comes with limits: the deduction generally can't exceed 65% of your taxable income for the year (the excess carries forward) or 100% of the net income from that property. Percentage depletion is available to royalty owners and independent producers but is largely denied to integrated major oil companies on their production. It applies to ongoing royalty income and is separate from the cost-recovery rules and from the capital-gains treatment that applies when you sell the minerals outright. Confirm specifics with a tax advisor.