What Is Depletion on Schedule C and How Is It Calculated?

Depletion on Schedule C is the deduction you take for the natural resources your business extracts and sells during the year, reported on Line 12 of Schedule C (Form 1040). If you operate as a sole proprietor or single-member LLC and you pump oil, mine minerals, quarry gravel, or harvest timber, depletion lets you recover the cost of the resource itself as it leaves the ground. For most mineral properties you calculate two versions of the deduction and claim the larger one. For timber, only one method is available.

Who Can Claim Depletion

You qualify only if you hold an economic interest in the deposit or standing timber. Under the regulations, that means you put capital into acquiring an interest in a resource still in the ground and you look to its extraction for a return on that investment.¹ A contract to buy or process minerals someone else has already extracted does not qualify.

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

Cost Depletion: The Basis-Based Method

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 you sold during the year.³ Your starting basis is generally what you paid for the mineral rights or timber, excluding the value of surface land and depreciable equipment.⁴

An example. You paid $200,000 for mineral rights on a property with 100,000 estimated recoverable tons. Your rate is $2 per ton. Sell 8,000 tons this year and cost depletion is $16,000. The remaining $184,000 in basis carries into future years.

If a later geological survey revises the recoverable units, you recompute the per-unit rate going forward using the remaining basis and the new estimate. You don’t amend prior years. Cost depletion stops once basis reaches zero.

Percentage Depletion: A Fixed Share of Gross Income

Percentage depletion applies a statutory percentage to your gross income from the property each year. The rates are set by Congress and don’t change annually.⁵ The commonly encountered tiers:

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

The 50% (or 100%) Taxable Income Cap

Percentage depletion for any property cannot exceed 50% of the taxable income from that property, figured before subtracting depletion itself. For oil and gas, the cap is 100% instead of 50%.⁵ Taxable income from the property is gross income minus every deductible expense tied to that property other than depletion.

The 65% Overall Cap for Oil and Gas

Even after clearing the property-level cap, total percentage depletion from all your oil and gas properties cannot exceed 65% of your overall taxable income for the year, computed without the oil and gas depletion deduction, the qualified business income deduction, or certain loss carrybacks. Any amount disallowed by this cap carries forward to the next year.⁶

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 cannot use it. Qualifying producers apply a 15% rate to domestic production, limited to an average daily production of 1,000 barrels of oil or the natural gas equivalent.⁶ Most Schedule C filers sit well under this limit.

Which Method to Claim

For mineral properties eligible for both methods, calculate both and claim whichever is larger. Percentage depletion tends to win once you’ve recovered a meaningful chunk of your original investment, because it’s tied to income rather than remaining basis. It can even continue after basis reaches zero, which cost depletion cannot.

Timber is the exception. Timber owners must use cost depletion. There is no percentage depletion option for standing timber.²

How to Report It

Enter the deduction on Line 12 of Schedule C (Form 1040), labeled “Depletion.”⁷ The amount reduces your gross profit and flows through to net profit or loss.

If you’re claiming depletion on timber, you generally must complete and attach Form T (Timber). It covers acquisitions, depletion schedules, and any sales or exchanges during the year. If you sell timber only occasionally, roughly once every three or four years, you can skip Form T as long as you keep adequate records.⁸

For mineral properties, the IRS doesn’t require a separate attachment. Keep a workbook for each property showing both the cost and percentage depletion calculations and documenting the larger figure you claimed.

Adjusting Basis Every Year: “Allowed or Allowable”

Each year you must reduce the property’s adjusted basis by the depletion allowed or allowable, whichever is greater.⁹ “Allowable” is the trap. If you forget to claim depletion in a given year, the IRS still treats your basis as if you had. You lose the deduction and take the basis reduction anyway. Skipping the deduction accidentally costs more than it appears, because the tax benefit is gone but the basis drop still happens.

Cost depletion stops when basis hits zero. Percentage depletion can keep going, which is what makes it valuable on long-producing properties.

What Happens When You Sell

Selling depleted natural resource property triggers Section 1254 recapture. On property placed in service after 1986, gain is treated as ordinary income (not capital gain) up to the total depletion deductions that reduced your basis, plus any intangible drilling costs and mining exploration or development expenses you deducted. The ordinary income recapture is capped at your actual gain on the sale.¹⁰ If you’ve been claiming depletion for years, don’t assume the sale will be taxed at capital gains rates.

Other Limits That Can Reduce or Suspend the Deduction

Two loss-limitation regimes can trim depletion before it lands on Schedule C. The at-risk rules cap your deductible losses from an activity at the amount you actually have on the line: cash invested, the adjusted basis of property you contributed, and amounts you borrowed for which you are personally liable. Nonrecourse loans and amounts protected by guarantees or stop-loss arrangements don’t count. Any depletion that pushes your losses past your at-risk amount is suspended until you have basis to absorb it.¹¹

The passive activity rules can also apply if you don’t materially participate in the extraction. There’s a carve-out worth knowing: a working interest in oil and gas held directly, or through an entity that doesn’t limit your liability, is automatically non-passive regardless of your participation.¹²

One AMT wrinkle to watch. Percentage depletion in excess of the property’s year-end adjusted basis (measured before that year’s depletion) is a tax preference item for the Alternative Minimum Tax. Oil and gas percentage depletion computed under the independent producer and royalty owner rules is excluded from this preference.¹³ For other minerals, once basis is at zero and you’re still claiming percentage depletion, the whole deduction becomes an AMT preference.

Lease Bonuses and Advance Royalties

If someone pays you a lease bonus for the right to extract minerals from your property, that payment qualifies for cost depletion. The deduction equals the share of your total depletion basis that the bonus represents relative to the bonus plus all expected future royalties. Remaining basis is then recovered through depletion on royalties as they come in.¹⁴ Get this allocation right at the start; a miscalculation upfront distorts every future year’s cost depletion.

1
eCFR. 26 CFR 1.611-1 – Allowance of Deduction for Depletion
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Internal Revenue Service. Tips on Reporting Natural Resource Income
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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. Schedule C (Form 1040) Profit or Loss From Business
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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
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eCFR. 26 CFR 1.612-3 – Depletion Treatment of Bonus and Advanced Royalty