Question

Frank purchased land containing oil reserves for $425,000. He has calculated his cost depletion for the year to be $20 per barrel for a total of $120,000 in depletion expense. He now needs to calculate his percentage depletion in case it is larger. His gross income from the oil extraction is $600,000 and he has $520,000 in operating expenses before depletion expense. Assuming this is domestic production, the amount of percentage depletion expense is $______1 of 3. If he uses this method he can deduct $________2 of 3 for tax purposes. He should use the______3 of 3 depletion method to maximize his deduction.

Answer 1

1 of 3. $52,000

2 of 3. $68,000

3 of 3 Percentage depletion

Step-by-step explanation:

The percentage depletion rate = 15% of gross income and limited to 65% of the net income

The gross income = $600,000

The operating expense = $520,000

The net income = $600,000 - $520,000 = $80,000

Therefore at 15% gross income, we have;

Percentage depletion rate = $600,000 × 0.15 = $90,000

65% of the net income gives;

$80,000 × 0.65 = $52,000

1 of 3. Therefore since 15% of the gross income ($90,000) > 65% of the net income($52,000), we have

The percentage depletion rate = $52,000

2 of 3. Therefore, he can deduct $120,000 - $52,000 = $68,000

3 of 3 He should therefore use the percentage depletion method to maximize his deductions

We therefore have;

Assuming this is domestic production, the amount of percentage depletion expense is _$52,000_. If he uses this method he can deduct _$68,000_ for tax purposes. He should use the _percentage depletion_ method to maximize his deductions.