Question

Last Chance Mine (LC) purchased a coal deposit for $750,000. It estimated it would extract 12,000 tons of coal from the deposit. LC mined the coal and sold it, reporting gross receipts of $1 million, $3 million, and $2 million for years 1 through 3, respectively. During years 1–3, LC reported net income (loss) from the coal deposit activity in the amount of ($20,000), $500,000, and $450,000, respectively. In years 1–3, LC actually extracted 13,000 tons of coal as follows:

(1) (2) Depletion (2)/(1) Tons Extracted per Year

Tons of Coal Basis Rate Year 1 Year 2 Year 3

12,000 $750,000 $62.50 2,000 7,200 3,800   

a.

What is Last Chance's cost depletion for years 1, 2, and 3?

  

b.

What is Last Chance's percentage depletion for each year (the applicable percentage for coal is 10 percent)?(Leave no answer blank. Enter zero if applicable.)

  

c.

Using the cost and percentage depletion computations from the previous parts, what is Last Chance’s actual depletion expense for each year?

  

Answer 1

(a) Last Chance's cost depletion for years 1, 2, and 3

Sl.No	Particulars	Year 1	Year 2	Year 3
1	Tons extracted	2,000	7,200	3,800
2	Depletion rate	62.50	62.50	62.50
3	Depletion Expense	125,000	450,000	175,000 (750,000 - 125,000 - 450,000)

Note: Under the cost depletion method, the taxpayer’s amortization is limited to the cost basis in the natural resource. The full amount of amortization would have been $237,500 if this is not the case.

(b) Last Chance’s percentage depletion for each year is calculated as follows:

Sl.No	Particulars	Year 1	Year 2	Year 3
1	Net income from activity (beforedepletion expense)	(20,000)	500,000	450,000
2	Gross Income	1,000,000	3,000,000	2,000,000
3	Percentage	10%	10%	10%
4	Percentage Depletion Expense before limit ( 2 x 3)	100,000	300,000	200,000
5	50% of net income limitation ( 1 x 50%)	0	250,000	225,000
6	Allowable percentage depletion (Lower of 4 and 5)	0	250,000	200,000

Note: Percentage depletion is not limited to the basis in the property.

(c) Last Chance’s actual depletion expense for each year:

Depletion expense is the greater of cost depletion or percentage depletion.

Sl.No	Particulars	Year 1	Year 2	Year 3
1	Cost depletion	125,000	450,000	175,000
2	Percentage depletion	0	250,000	200,000
3	Deductible depletion expense (Higher of 1 and 2)	125,000	450,000	200,000

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