Depletion on Schedule C: Cost vs. Percentage, Limits, and Recapture

Depletion on Schedule C is the deduction sole proprietors and single-member LLCs use to recover the cost of natural resources their business extracts and sells. You report it on Line 12 of Schedule C (Form 1040), and for most mineral properties you calculate the deduction two different ways and claim whichever produces the larger number.¹ Timber is the one common exception: it’s restricted to cost depletion.²

Who Can Claim It

You need an economic interest in the deposit or standing timber. Under IRS regulations, that means you put capital into acquiring an interest in a resource still in the ground and you look to its extraction or sale for your return.³ A contract to buy or process someone else’s minerals after they’ve been pulled out of the ground doesn’t qualify.

Qualifying resources include oil, natural gas, coal, geothermal deposits, timber, and a wide range of metals and minerals. Water and ordinary soil generally don’t qualify unless the soil contains a mineral deposit.²

Cost Depletion

Cost depletion spreads your adjusted basis in the property across the total estimated recoverable units. Divide basis by total recoverable units to get a per-unit rate, then multiply that rate by the units sold during the year.⁴ Your adjusted basis starts with what you paid to acquire the mineral rights or timber, excluding the value of surface land and depreciable equipment.⁵

Say you paid $200,000 for mineral rights on a property with an estimated 100,000 recoverable tons. Your rate is $2 per ton. Sell 8,000 tons this year and your cost depletion is $16,000. The remaining $184,000 in basis carries forward.

If a new geological survey revises the recoverable estimate, you use the remaining basis and the updated estimate to compute a new rate going forward. You don’t amend prior years. Once basis hits zero, cost depletion stops.

Percentage Depletion

Percentage depletion applies a fixed statutory percentage to your gross income from the property. Rates are set by statute and don’t change annually. The most commonly encountered tiers:⁶

22% for sulfur and uranium, plus a list of strategic minerals such as lithium, cobalt, and tungsten from U.S. deposits
15% for gold, silver, copper, and iron ore from U.S. deposits, plus oil shale
14% for other metal mines and most catch-all minerals like limestone, granite, marble, and phosphate rock
10% for coal, lignite, perlite, and sodium chloride
5% for gravel, sand, pumice, peat, and common stone

Income Caps

Percentage depletion is subject to a property-level cap: it can’t exceed 50% of your taxable income from the property, computed before the depletion deduction. For oil and gas properties, that cap rises to 100% of taxable income from the property.⁶ Taxable income from the property means gross income minus all deductible expenses tied to that property, other than depletion.

Oil and gas has a second cap: total percentage depletion from all your oil and gas properties can’t exceed 65% of your overall taxable income for the year, computed without the oil and gas depletion deduction, any qualified business income deduction, and certain loss carrybacks. Any amount disallowed by the 65% cap carries forward to the next year.⁷

Oil and Gas: Independent Producers Only

For oil and gas wells, percentage depletion is available only to independent producers and royalty owners; major integrated oil companies can’t use it. The 15% rate applies to domestic production up to an average daily production of 1,000 barrels of oil or the natural gas equivalent.⁷ Most Schedule C filers sit well below that threshold.

Picking the Larger Deduction

For any mineral property eligible for both methods, calculate cost and percentage depletion and claim whichever is larger. Percentage depletion often wins once you’ve recovered a meaningful share of your original investment, because it’s tied to income rather than remaining basis. Over the life of a productive property, cumulative percentage depletion can exceed what you originally paid, which cost depletion never does.

Timber owners don’t get the choice. Only cost depletion is available for standing timber.²

Reporting the Deduction

Put the depletion amount on Line 12 of Schedule C, labeled “Depletion.”¹ It reduces your gross profit and flows through to net profit or loss.

If the deduction is for timber, complete and attach Form T (Timber). Form T covers acquisitions, depletion schedules, and any sales or exchanges. You can skip Form T if you sell timber only occasionally, roughly once every three or four years, provided you keep adequate records.⁸

For mineral properties, no separate attachment is required, but keep detailed workbooks showing both cost and percentage depletion calculations for each property. On audit, you’ll need to demonstrate the math and show you claimed the correct (larger) amount.

Basis Goes Down Every Year

Each year, your property’s adjusted basis drops by the depletion allowed or allowable, whichever is greater.⁹ The “or allowable” language is a trap. If you forget to claim depletion in a given year, the IRS still treats your basis as reduced by what you could have claimed. You lose the deduction and the basis goes down anyway.

Cost depletion stops when basis hits zero. Percentage depletion doesn’t; it can continue after basis is exhausted, which is what makes it valuable for long-producing wells and mines.

Recapture When You Sell

Selling natural resource property triggers Section 1254 recapture. For property placed in service after 1986, gain on the sale is treated as ordinary income (not capital gain) to the extent of prior depletion deductions that reduced basis, plus any intangible drilling costs and mining exploration or development expenses you deducted.¹⁰ The recapture is capped at your actual gain, so it won’t manufacture income beyond what you received. Plan for this before selling a heavily depleted property; the favorable capital gains rate won’t apply to the recaptured portion.

Other Limits That Can Cut the Deduction

Two loss-limitation regimes can restrict depletion before it ever reduces your Schedule C bottom line.

The at-risk rules cap deductible losses at the amount you have on the line financially: cash invested, adjusted basis of property contributed, and amounts borrowed for which you’re personally liable. Nonrecourse loans and amounts shielded by guarantees or stop-loss arrangements don’t count.¹¹ Losses above your at-risk amount are suspended and carry forward.

The passive activity rules add a second filter. If you don’t materially participate, losses (including depletion) can only offset income from other passive activities. Oil and gas gets a carve-out: a working interest you hold directly, or through an entity that doesn’t limit your liability, is automatically non-passive regardless of participation.¹²

AMT

Percentage depletion in excess of the property’s adjusted basis at year-end (measured before that year’s depletion) is a tax preference item for the Alternative Minimum Tax. Percentage depletion on oil and gas computed under the independent producer and royalty owner rules is excluded from this preference entirely.¹³ For other minerals, once basis is at zero, continued percentage depletion becomes a preference amount that can raise AMT.

1
Internal Revenue Service. Schedule C (Form 1040) Profit or Loss From Business
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Internal Revenue Service. Tips on Reporting Natural Resource Income
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eCFR. 26 CFR 1.611-1 – Allowance of Deduction for Depletion
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Internal Revenue Service. Publication 535 – Business Expenses
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Office of the Law Revision Counsel. 26 USC 612 – Basis for Cost Depletion
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Office of the Law Revision Counsel. 26 USC 613 – Percentage Depletion
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Office of the Law Revision Counsel. 26 USC 613A – Limitations on Percentage Depletion in Case of Oil and Gas Wells
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Internal Revenue Service. Instructions for Form T (Timber)
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Office of the Law Revision Counsel. 26 USC 1016 – Adjustments to Basis
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eCFR. 26 CFR 1.1254-1 – Treatment of Gain From Disposition of Natural Resource Recapture Property
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Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk
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Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
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Office of the Law Revision Counsel. 26 USC 57 – Items of Tax Preference