Legal Definitions - depletion allowance

A depletion allowance is a specific tax deduction available to businesses that extract or harvest natural resources. It allows these businesses to account for the gradual reduction in the value and quantity of their natural resource assets (such as oil, gas, minerals, or timber) as they are removed from the earth or harvested. This deduction helps companies recover their capital investment in these finite resources over time, much like depreciation accounts for the wear and tear of manufactured assets.

• Example 1: Oil and Gas Extraction

  An energy company owns the rights to an oil field and begins extracting crude oil. As millions of barrels of oil are pumped out of the ground each year, the total reserves within that field diminish. The depletion allowance permits this company to deduct a portion of its income generated from selling the extracted oil. This deduction reflects the decreasing value of the oil field itself as its primary asset (the oil) is consumed, helping the company recover its initial investment in acquiring and developing the field.

• Example 2: Mineral Mining

  A mining corporation operates a large open-pit gold mine. Annually, they extract a significant quantity of gold ore, which is then processed and sold. The depletion allowance allows the corporation to claim a tax deduction based on the amount of gold removed from the mine. This acknowledges that the mine's valuable mineral reserves are being exhausted, and the deduction helps the company recoup its substantial investment in the mine as the precious metal is extracted and sold.

• Example 3: Timber Harvesting

  A commercial logging company manages a vast tract of forest land for timber production. When they selectively harvest mature trees, the overall volume of standing timber in their forest inventory decreases. The depletion allowance enables the company to deduct a portion of the income earned from selling the harvested logs. This deduction accounts for the reduction in the forest's timber resource, allowing the company to recover its investment in the timber as it is cut down and brought to market.