7870 / What is the depletion allowance?

The depletion allowance is a formula for computing and excluding (i.e., by way of income tax deductions) from the proceeds of mineral operations the portion of the proceeds which represents a tax-free return of an investor’s capital.¹ In other words, the depletion allowance is an income tax deduction that compensates the owner of wasting mineral assets (e.g., oil or gas) “for the part exhausted in production, so that when the minerals are gone, the owner’s capital and his capital assets remain unimpaired.”² Depletion is similar in concept to depreciation (see Q 716).

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1.  See Jefferson Lake Sulphur Co. v. Lambert, 133 F. Supp. 197 (E.D. La. 1955), aff’d, 236 F.2d 542 (5th Cir. 1956).

2.  Paragon Jewel Coal Co., Inc. v. Comm., 380 U.S. 624 (1965).

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