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Stephen G.
Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 4010
Experience:  Extensive Experience with Tax, Financial & Estate Issues
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My husband inherited 3 oil wells from his uncle who purchased

Resolved Question:

My husband inherited 3 oil wells from his uncle who purchased them in 1957. The oil wells are working Interest wells. We have been told that we are entitled to 15% depletion benefits because they have never been sold. My accountant is unaware of this, is this true?
Submitted: 11 months ago.
Category: Tax
Expert:  Stephen G. replied 11 months ago.

Stephen G. :

Hi & thanks for using our service. I'll do my best to give you a complete & accurate answer. Please ask me to clarify anything that is not clear.

Stephen G. :

I don't know what your reference to the wells having "never been sold".

Stephen G. :

As a working interest in the wells you are responsible for all the costs associated with the wells; is this the case in the wells you own?

Stephen G. :

The 15% depletion replaces depreciation & it is figured on the gross revenue.

Customer:

We have an 18% interest in the wells. My question to you are you familiar with tax laws associated with oil wells?

Stephen G. :

Sure.

Customer:

Is that all you have to say about the depletion laws for working interest oil wells ?

Stephen G. :

You asked about depletion and I answered. It doesn't matter what your interest is, if you have a working interest in the wells then you would be responsible for your share of all the drilling costs etc.

Stephen G. :

What else do you want to know about depletion?

Customer:

What are the tax consequenses for WI tax benefits? Is there a formula? Some have said that depletion is only for royalties?

Stephen G. :

It can be for both passive and non-passive interests in oil & gas wells; the IRS considers a working interest a non-passive interest and therefore losses are deductible against your other ordinary income.

Customer:

I am not satisfied with your response and feel that it is a superficial response.

Stephen G. :

Let me give you a link to an article that you may find helpful. You haven't answered my questions about the expenses which determines their classification as a working interest; that can change over time based upon how the oil is extracted.

Customer:

I am billed every month for expenses each month. These expenses are deducted from the gross at the end of the year.

Stephen G. :

OK, that's what I was asking; This is an article that explains that working interests are entitled to depletion. The logic is that the oil & gas are wasting assets and therefore as those assets are depleted you are entitled to a deduction for that "depletion".

Stephen G. :

There can be increased depletion rates for "heavy oil", but you would know if that applied to you.

Customer:

Where is the link to the article? Does it give a formula?

Stephen G. :

http://www.rkingco.com/mineral-owners/oil-and-gas-royalty-income-taxes/

Customer:

I need to read the article but can not while this is in session. Can you send the link to my e mail.?XXXXX@XXXXXX.XXX

Stephen G. :

Unfortunately, the email comes through here as all "xxx" as we aren't allowed to communicate with customers outside of JustAnswer.com. You should be able to highlight the link & right click and have google find the link on the internet without leaving here; ie. when you close the link you should come right back where you were.

Customer:

this does not answer my question about WI oil wells getting 15% depletion tax benefit.

Stephen G. :

Now when you mentioned a formula, you are talking about "cost depletion" which gets into some fairly difficult computations as you need a lot more information in order to make the computations. You are much better off simply using percentage depletion.

Stephen G. :

What else do you want to know?

Customer:

I am not satisfied

Stephen G. :

Your question was "My accountant is unaware of this, is it true"?

Stephen G. :

I answered your question; just tell me what you want to know?

Stephen G. :

How can you rate me as giving you poor service if you don't tell me what you want to know?

Stephen G. :

You said you have been told that you are entitled to 15% depletion; what is the problem?

Stephen G. :

You either have cost depletion or percentage depletion.

Stephen G. :

As long as you are an independent oil producer (ie. working interest) or a royalty owner, you can use percentage depletion rather than cost depletion. See IRS Publication 535 as follows:

Stephen G. :

Independent Producers and Royalty Owners


If you are an independent producer or royalty owner, you figure percentage depletion using a rate of 15% of the gross income from the property based on your average daily production of domestic crude oil or domestic natural gas up to your depletable oil or natural gas quantity. However, certain refiners, as explained next, and certain retailers and transferees of proven oil and gas properties, as explained next, cannot claim percentage depletion.

Stephen G. :

Here are further specific examples of the computation based upon the limits imposed with respect to barrels of oil produced as well as cubic feet of gas; reproduced here so you don't have to find the material in Publication 535;

Stephen G. :

Figuring percentage depletion. Generally, as an independent producer or royalty owner, you figure your percentage depletion by computing your average daily production of domestic oil or gas and comparing it to your depletable oil or gas quantity. If your average daily production does not exceed your depletable oil or gas quantity, you figure your percentage depletion by multiplying the gross income from the oil or gas property (defined later) by 15%. If your average daily production of domestic oil or gas exceeds your depletable oil or gas quantity, you must make an allocation as explained later under Average daily production.


In addition, there is a limit on the percentage depletion deduction. See Taxable income limit , later.


Average daily production. Figure your average daily production by dividing your total domestic production of oil or gas for the tax year by the number of days in your tax year.

Partial interest. If you have a partial interest in the production from a property, figure your share of the production by multiplying total production from the property by your percentage of interest in the revenues from the property. You have a partial interest in the production from a property if you have a net profits interest in the property. To figure the share of production for your net profits interest, you must first determine your percentage participation (as measured by the net profits) in the gross revenue from the property. To figure this percentage, you divide the income you receive for your net profits interest by the gross revenue from the property. Then multiply the total production from the property by your percentage participation to figure your share of the production.

Example.


John Oak owns oil property in which Paul Elm owns a 20% net profits interest. During the year, the property produced 10,000 barrels of oil, which John sold for $200,000. John had expenses of $90,000 attributable to the property. The property generated a net profit of $110,000 ($200,000 − $90,000). Paul received income of $22,000 ($110,000 × .20) for his net profits interest.


Paul determined his percentage participation to be 11% by dividing $22,000 (the income he received) by $200,000 (the gross revenue from the property). Paul determined his share of the oil production to be 1,100 barrels (10,000 barrels × 11%).




Depletable oil or natural gas quantity. Generally, your depletable oil quantity is 1,000 barrels. Your depletable natural gas quantity is 6,000 cubic feet multiplied by the number of barrels of your depletable oil quantity that you choose to apply. If you claim depletion on both oil and natural gas, you must reduce your depletable oil quantity (1,000 barrels) by the number of barrels you use to figure your depletable natural gas quantity.

Example.


You have both oil and natural gas production. To figure your depletable natural gas quantity, you choose to apply 360 barrels of your 1000-barrel depletable oil quantity. Your depletable natural gas quantity is 2.16 million cubic feet of gas (360 × 6000). You must reduce your depletable oil quantity to 640 barrels (1000 − 360).



Stephen G. :

Depending upon how your accountant prepares your income tax returns, most of our tax preparation software will make these computations automatically once you fill in the information.

Stephen G. :

Most people do not have sufficient production to come up against the total barrels and cubic feet limitations imposed by the code. That simplifies things.

Stephen G. :

I really don't know what else I can tell you based upon the information you provided, but I'm willing to answer any follow-up questions you may have. I've provided this additional information as I don't know what else you are searching for, but if you tell me I will respond.

Stephen G. :

However, rating me as giving you "poor service" when I answered your initial question and have been unable to get you to specify what else you want, is simply not fair. I'd appreciate if you would provide an additional acceptable rating as only the last one counts.

Customer:

We are not Royalty Owners , we have a working interest in three wells. Since we are working interest only, we would like to know what the tax ramifications are for these wells. Are we allowed to take a depletion allowance on wells that are 57 yrs old.

Customer:

 


the information given appears to apply to Royalty Owners

Stephen G. :

Yes

Stephen G. :

No. That is not correct; it applies to independent producers also. Your tax basis in the oil wells is the fair market value of the wells at the date the decedent died and left the wells to your husband.

Stephen G. :

With percentage depletion, you aren't limited to your cost (tax basis) in the wells; you are limited by the number of barrels of oil you produce as shown in the above examples. Once your accountant, if he is qualified, (as an independent producer you should be using a CPA), looks it up, he should be able to make the computations for you.

Stephen G. :

Basically, it is going to come out as 15% of the gross revenue from the wells for your 18% interest.

Stephen G. :

If you haven't been claiming the depletion right along, you can file amended returns to claim the depletion and obtain refunds of the income tax that was overpaid.

Customer:

OK, thank you very much, this now makes sense to us

Stephen G. :

You are welcome.

Stephen G., Sr Income Tax Expert
Category: Tax
Satisfied Customers: 4010
Experience: Extensive Experience with Tax, Financial & Estate Issues
Stephen G. and 4 other Tax Specialists are ready to help you

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