The adjusted basis can never be less than zero. The adjusted basis of property is the original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed and casualty losses. The following information is necessary for determining cost depletion: However, they can use percentage depletion deduction which will be described more in detail later in this fact sheet. Because of this, most landowners will not be able to use the cost depletion method. In Ohio, it is not common for landowners to allocate part of the basis to the oil and gas reserves. When establishing the basis, the landowner splits the value of the property at acquisition among these different capital assets. The basis usually includes the value of the land and its associated capital assets such as timber, equipment, buildings, and oil/gas. The cost basis of a property is usually determined upon its acquisition (by purchase, inheritance, gift). This method is tied to the landowner's basis in the property. The IRS requires a landowner to compare two methods when determining the depletion deduction, and to use the method which provides the largest deduction. Therefore, this deduction is not an applicable deduction against lease bonus payments but is for royalty payments. Third, the deduction is allowed only when oil or gas is actually sold and income is reportable. Second, the landowner must have a legal right to income from the oil and gas extraction. First, the landowner must have an ownership interest in the mineral property. Three factors determine whether a landowner qualifies for the depletion deduction. The IRS defines depletion as "the using up of natural resources by mining, quarrying, drilling, or felling." Recognizing that oil, gas, and other minerals are used up or depleted as they are extracted, the IRS allows for a reasonable income tax deduction based on depletion of the mineral resource. Landowners who have active oil and gas extraction on their property may be able to reduce their income tax liability for their royalty payments by using what the Internal Revenue Service (IRS) refers to as the "depletion deduction." What is the depletion deduction?
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