7882 / Is percentage depletion available with respect to advance royalties or lease bonuses?

No. Percentage depletion is not available with respect to advance royalties or lease bonuses.¹ Prior to TRA ’86, gross income received in the form of advance royalties or lease bonuses was eligible for percentage depletion by a “small producer” (see Q 7878) even though no oil or natural gas had as yet been extracted from the ground (the “Engle rule”).² According to the Service, however, this depletion deduction had to be taken in the year in which the lease bonus or advanced royalty payment was includable in the gross income of the taxpayer.³

If the economic interest in the property expires, terminates, or is abandoned before income has been derived from production (in the case of a lease bonus), or before the royalty has been recouped from production (in the case of an advanced royalty), the taxpayer is required to adjust the capital account by restoring any excess depletion deduction taken under the Engle rule and to include the excess in income in the year the expiration, termination, or abandonment occurs.⁴

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1.  IRC § 613A(d)(5).

2.  Comm. v. Engle, 84-1 USTC ¶ 9134 (U.S. 1984).

3.  Treas. Reg. § 1.613A-3(j)(2).