[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.611-2]

[Page 394-400]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.611-2  Rules applicable to mines, oil and gas wells, and other 
natural deposits.

    (a) Computation of cost depletion of mines, oil and gas wells, and 
other natural deposits. (1) The basis upon which cost depletion is to be 
allowed in respect of any mineral property is the basis provided for in 
section 612 and the regulations thereunder. After the amount of such 
basis applicable to the mineral property has been determined for the 
taxable year, the cost depletion for that year shall be computed by 
dividing such amount by the number of units of mineral remaining as of 
the taxable year (see subparagraph (3) of this paragraph), and by 
multiplying the depletion unit, so determined, by the number of units of 
mineral sold within the taxable year (see subparagraph (2) of this 
paragraph). In the selection of a unit of mineral for depletion, 
preference shall be given to the principal or customary unit or units 
paid for in the products sold, such as tons of ore, barrels of oil, or 
thousands of cubic feet of natural gas.
    (2) As used in this paragraph, the phrase number of units sold 
within the taxable year:
    (i) In the case of a taxpayer reporting income on the cash receipts 
and disbursements method, includes units for which payments were 
received within the taxable year although produced or sold prior to the 
taxable year, and excludes units sold but not paid for in the taxable 
year, and
    (ii) In the case of a taxpayer reporting income on the accrual 
method, shall be determined from the taxpayer's inventories kept in 
physical quantities and in a manner consistent with his method of 
inventory accounting under section 471 or 472.

The phrase does not include units with respect to which depletion 
deductions were allowed or allowable prior to the taxable year.
    (3) The number of units of mineral remaining as of the taxable year 
is the number of units of mineral remaining

[[Page 395]]

at the end of the year to be recovered from the property (including 
units recovered but not sold) plus the number of units sold within the 
taxable year as defined in this section.
    (4) In the case of a natural gas well where the annual production is 
not metered and is not capable of being estimated with reasonable 
accuracy, the taxpayer may compute the cost depletion allowance in 
respect of such property for the taxable year by multiplying the 
adjusted basis of the property by a fraction, the numerator of which is 
equal to the decline in rock pressure during the taxable year and the 
denominator of which is equal to the expected total decline in rock 
pressure from the beginning of the taxable year to the economic limit of 
production. Taxpayers computing depletion by this method must keep 
accurate records of periodical pressure determinations.
    (5) If an aggregation of two or more separate mineral properties is 
made during a taxable year under section 614, cost depletion for each 
such property shall be computed separately for that portion of the 
taxable year ending immediately before the effective date of the 
aggregation. Cost depletion with respect to the aggregated property 
shall be computed for that portion of the taxable year beginning on such 
effective date. The allowance for cost depletion for the taxable year 
shall be the sum of such cost depletion computations. For purposes of 
this paragraph, each such portion of the taxable year shall be 
considered as a taxable year. Similar rules shall be applied where a 
separate mineral property is properly removed from an existing 
aggregation during a taxable year. See section 614 and the regulations 
thereunder for rules relating to the effective date of an aggregation of 
mineral interests and for rules relating to the adjusted basis of an 
aggregation.
    (6) The apportionment of the deduction among the several owners of 
economic interests in the mineral deposit or deposits will be made as 
provided in paragraph (c) of Sec. 1.611-1.
    (b) Depletion accounts of mineral property. (1) Every taxpayer 
claiming and making a deduction for depletion of mineral property shall 
keep a separate account in which shall be accurately recorded the cost 
or other basis provided by section 1012, of such property together with 
subsequent allowable capital additions to each account and all the other 
adjustments required by section 1016.
    (2) Mineral property accounts shall thereafter be credited annually 
with the amounts of the depletion so computed in accordance with section 
611 or 613 and the regulations thereunder; or the amounts of the 
depletion computed in shall be credited to depletion reserve accounts. 
No further deductions for cost depletion shall be allowed when the sum 
of the credits for depletion equals the cost or other basis of the 
property, plus allowable capital additions. However, depletion 
deductions may be allowable thereafter computed upon a percentage of 
gross income from the property. See section 613 and the regulations 
thereunder. In no event shall percentage depletion in excess of cost or 
other basis of the property be credited to the improvements account or 
the depreciation reserve account.
    (c) Determination of mineral contents of deposits. (1) If it is 
necessary to estimate or determine with respect to any mineral deposit 
as of any specific date the total recoverable units (tons, pounds, 
ounces, barrels, thousands of cubic feet, or other measure) of mineral 
products reasonably known, or on good evidence believed, to have existed 
in place as of that date, the estimate or determination must be made 
according to the method current in the industry and in the light of the 
most accurate and reliable information obtainable. In the selection of a 
unit of estimate, preference shall be given to the principal unit (or 
units) paid for in the product marketed. The estimate of the recoverable 
units of the mineral products in the deposit for the purposes of 
valuation and depletion shall include as to both quantity and grade:
    (i) The ores and minerals in sight, blocked out, developed, or 
assured, in the usual or conventional meaning of these terms with 
respect to the type of the deposits, and
    (ii) Probable or prospective ores or minerals (in the corresponding 
sense),

[[Page 396]]

that is, ores or minerals that are believed to exist on the basis of 
good evidence although not actually known to occur on the basis of 
existing development. Such probable or prospective ores or minerals may 
be estimated:
    (a) As to quantity, only in case they are extensions of known 
deposits or are new bodies or masses whose existence is indicated by 
geological surveys or other evidence to a high degree of probability, 
and
    (b) As to grade, only in accordance with the best indications 
available as to richness.
    (2) If the number of recoverable units of mineral in the deposit has 
been previously estimated for the prior year or years, and if there has 
been no known change in the facts upon which the prior estimate was 
based, the number of recoverable units of mineral in the deposit as of 
the taxable year will be the number remaining from the prior estimate. 
However, for any taxable year for which it is ascertained either by the 
taxpayer or the district director from any source, such as operations or 
development work prior to the close of the taxable year, that the 
remaining recoverable mineral units as of the taxable year are 
materially greater or less than the number remaining from the prior 
estimate, then the estimate of the remaining recoverable units shall be 
revised, and the annual cost depletion allowance with respect to the 
property for the taxable year and for subsequent taxable years will be 
based upon the revised estimate until a change in the facts requires 
another revision. Such revised estimate will not, however, change the 
adjusted basis for depletion.
    (d) Determination of fair market value of mineral properties, and 
improvements, if any. (1) If the fair market value of the mineral 
property and improvements at a specified date is to be determined for 
the purpose of ascertaining the basis, such value must be determined, 
subject to approval or revision by the district director, by the owner 
of such property and improvements in the light of the conditions and 
circumstances known at that date, regardless of later discoveries or 
developments or subsequent improvements in methods of extraction and 
treatment of the mineral product. The district director will give due 
weight and consideration to any and all factors and evidence having a 
bearing on the market value, such as cost, actual sales and transfers of 
similar properties and improvements, bona fide offers, market value of 
stock or shares, royalties and rentals, valuation for local or State 
taxation, partnership accountings, records of litigation in which the 
value of the property and improvements was in question, the amount at 
which the property and improvements may have been inventoried or 
appraised in probate or similar proceedings, and disinterested 
appraisals by approved methods.
    (2) If the fair market value must be ascertained as of a certain 
date, analytical appraisal methods of valuation, such as the present 
value method will not be used:
    (i) If the value of a mineral property and improvements, if any, can 
be determined upon the basis of cost or comparative values and 
replacement value of equipment, or
    (ii) If the fair market value can reasonably be determined by any 
other method.
    (e) Determination of the fair market value of mineral property by 
the present value method. (1) To determine the fair market value of a 
mineral property and improvements by the present value method, the 
essential factors must be determined for each mineral deposit. The 
essential factors in determining the fair market value of mineral 
deposits are:
    (i) The total quantity of mineral in terms of the principal or 
customary unit (or units) paid for in the product marketed,
    (ii) The quantity of mineral expected to be recovered during each 
operating period,
    (iii) The average quality or grade of the mineral reserves,
    (iv) The allocation of the total expected profit to the several 
processes or operations necessary for the preparation of the mineral for 
market,
    (v) The probable operating life of the deposit in years,
    (vi) The development cost,
    (vii) The operating cost,
    (viii) The total expected profit,

[[Page 397]]

    (ix) The rate at which this profit will be obtained, and
    (x) The rate of interest commensurate with the risk for the 
particular deposit.
    (2) If the mineral deposit has been sufficiently developed, the 
valuation factors specified in subparagraph (1) of this paragraph may be 
determined from past operating experience. In the application of factors 
derived from past experience, full allowance should be made for probable 
future variations in the rate of exhaustion, quality or grade of the 
mineral, percentage of recovery, cost of development, production, 
interest rate, and selling price of the product marketed during the 
expected operating life of the mineral deposit. Mineral deposits for 
which these factors cannot be determined with reasonable accuracy from 
past operating experience may also be valued by the present value 
method; but the factors must be deduced from concurrent evidence, such 
as the general type of the deposit, the characteristics of the district 
in which it occurs, the habit of the mineral deposits, the intensity of 
mineralization, the oil-gas ratio, the rate at which additional mineral 
has been disclosed by exploitation, the stage of the operating life of 
the deposit, and any other evidence tending to establish a reasonable 
estimate of the required factors.
    (3) Mineral deposits of different grades, locations, and probable 
dates of extraction should be valued separately. The mineral content of 
a deposit shall be determined in accordance with paragraph (c) of this 
section. In estimating the average grade of the developed and 
prospective mineral, account should be taken of probable increases or 
decreases as indicated by the operating history. The rate of exhaustion 
of a mineral deposit should be determined with due regard to the 
limitations imposed by plant capacity, by the character of the deposit, 
by the ability to market the mineral product, by labor conditions, and 
by the operating program in force or reasonably to be expected for 
future operations. The operating life of a mineral deposit is that 
number of years necessary for the exhaustion of both the developed and 
prospective mineral content at the rate determined as above. The 
operating life of oil and gas wells is also influenced by the natural 
decline in pressure and flow, and by voluntary or enforced curtailment 
of production. The operating cost includes all current expense of 
producing, preparing, and marketing the mineral product sold (due 
consideration being given to taxes) exclusive of allowable capital 
additions, as described in Sec. Sec. 1.612-2 and 1.612-4, and 
deductions for depreciation and depletion, but including cost of 
repairs. This cost of repairs is not to be confused with the 
depreciation deduction by which the cost of improvements is returned to 
the taxpayer free from tax. In general, no estimates of these factors 
will be approved by the district director which are not supported by the 
operating experience of the property or which are derived from different 
and arbitrarily selected periods.
    (4) The value of each mineral deposit is measured by the expected 
gross income (the number of units of mineral recoverable in marketable 
form multiplied by the estimated market price per unit) less the 
estimated operating cost, reduced to a present value as of the date for 
which the valuation is made at the rate of interest commensurate with 
the risk for the operating life, and further reduced by the value at 
that date of the improvements and of the capital additions, if any, 
necessary to realize the profits. The degree of risk is generally lowest 
in cases where the factors of valuation are fully supported by the 
operating record of the mineral enterprise before the date for which the 
valuation is made. On the other hand, higher risks ordinarily attach to 
appraisals upon any other basis.
    (f) Revaluation of mineral property not allowed. No revaluation of a 
mineral property whose value as of any specific date has been determined 
and approved will be made or allowed during the continuance of the 
ownership under which the value was so determined and approved, except 
in the case of misrepresentation or fraud or gross error as to any facts 
known on the date as of which the valuation was made. Revaluation on 
account of misrepresentation or fraud or such gross error will be

[[Page 398]]

made only with the written approval of the Commissioner.
    (g) Statement to be attached to return when valuation, depletion, or 
depreciation of mineral property or improvements are claimed. (1) For 
the first taxable year ending before December 31, 1967, for which a 
taxpayer asserts a value for any mineral property or improvement as of a 
specific date or claims a deduction for depletion, or depreciation, 
there shall be attached to the return of the taxpayer for such taxable 
year a statement setting forth, in complete, summary form, the pertinent 
information required by this paragraph with respect to each such mineral 
property or improvement (including oil and gas properties or 
improvements). The summary statement shall be deemed a part of the 
income tax return to which it relates. In addition to such summary 
statement, the taxpayer must assemble, segregate and have readily 
available at his principal place of business, all the supporting data 
(listed in subparagraphs (2), (3), and (4) of this paragraph) which is 
used in compiling the summary statement. For taxable years after such 
first taxable year, and ending before December 31, 1967, the taxpayer 
need attach to his return only an explanation of the changes, if any, in 
the information previously furnished. For example, when a taxpayer has 
filed adequate maps with the district director he may be relieved of 
filing further maps of the same area, if all additional information 
necessary for keeping the maps up-to-date is filed each year. In any 
case in which any of the information required by this paragraph has been 
previously filed by the taxpayer (including information furnished in 
accordance with corresponding provisions of prior regulations), such 
information need not be filed again, but a statement should be attached 
to the return of the taxpayer indicating clearly when and in what form 
such information was previously filed. For provisions relating to the 
data which shall be submitted with returns for taxable years ending on 
or after December 31, 1967, see subparagraph (5) of this paragraph.
    (2) The information referred to in subparagraph (1) of this 
paragraph is as follows:
    (i) An adequate map showing the name, description, location, date of 
surveys, and identification of the deposit or deposits;
    (ii) A description of the character of the taxpayer's property, 
accompanied by a copy of the instrument or instruments by which it was 
acquired;
    (iii) The date of acquisition of the property, the exact terms and 
dates of expiration of all leases involved, and if terminated, the 
reasons therefor;
    (iv) The cost of the mineral property and improvements, stating the 
amount paid to each vendor, with his name and address;
    (v) The date as of which the mineral property and improvements are 
valued, if a valuation is necessary to establish the basis as provided 
by section 1012;
    (vi) The value of the mineral property and improvements on that date 
with a statement of the precise method by which it was determined;
    (vii) An allocation of the cost or value among the mineral property, 
improvements and the surface of the land for purposes other than mineral 
production;
    (viii) The estimated number of units of each kind of mineral at the 
end of the taxable year, and also at the date of acquisition, if 
acquired during the taxable year or at the date as of which any 
valuation is made, together with an explanation of the method used in 
the estimation, the name and address of the person making the estimate, 
and an average analysis which will indicate the quality of the mineral 
valued, including the grade or gravity in the case of oil;
    (ix) The number of units sold and the number of units for which 
payment was received or accrued during the year for which the return is 
made (in the case of newly developed oil and gas deposits it is 
desirable that this information be furnished by months);
    (x) The gross amount received from the sale of mineral;
    (xi) The amount of depreciation for the taxable year and the amount 
of cost depletion for the taxable year;
    (xii) The amounts of depletion and depreciation, if any, stated 
separately, which for each and every prior year:
    (a) Were allowed (see section 1016(a)(2)),

[[Page 399]]

    (b) Were allowable, and
    (c) Would have been allowable without reference to percentage or 
discovery depletion;
    (xiii) The fractions (however measured) of gross production from the 
deposit or deposits to which the taxpayer and other persons are entitled 
together with the names and addresses of such other persons; and
    (xiv) Any other data which will be helpful in determining the 
reasonableness of the valuation asserted or of the deductions claimed.
    (3) In the case of oil and gas properties, the following information 
with respect to each property is required in addition to that 
information set forth in subparagraph (2) of this paragraph:
    (i) The number of acres of producing oil or gas land and, if 
additional acreage is claimed to be proven, the amount of such acreage 
and the reasons for believing it to be proven;
    (ii) The number of wells producing at the beginning and end of the 
taxable year;
    (iii) The date of completion of each well finished during the 
taxable year;
    (iv) The date of abandonment of each well abandoned during the 
taxable year;
    (v) Maps showing the location of the tracts or leases and of the 
producing and abandoned wells, dry holes, and proven oil and gas lands 
(the maps should show depth, initial production, and date of completion 
of each well, etc., to the extent that these data are available);
    (vi) The number of pay sands and average thickness of each pay sand 
or zone;
    (vii) The average depth to the top of each of the different pay 
sands;
    (viii) The annual production of the deposit or of the individual 
wells, if the latter information is available, from the beginning of its 
productivity to the end of the taxable year, the average number of wells 
producing during each year, and the initial daily production of each 
well (the extent to which oil or gas is used for fuel on the premises 
should be stated with reasonable accuracy);
    (ix) All available data regarding change in operating conditions, 
such as unit operation, proration, flooding, use of air-gas lift, 
vacuum, shooting, and similar information, which have a direct effect on 
the production of the deposit; and
    (x) Available geological information having a probable bearing on 
the oil and gas content; information with respect to edge water, water 
drive, bottom hole pressures, oil-gas ratio, porosity of reservoir rock, 
percentage of recovery, expected date of cessation of natural flow, 
decline in estimated potential, and characteristics similar to 
characteristics of other known fields.
    (4) For rules relating to an additional statement to be attached to 
the return when the depletion deduction is computed upon a percentage of 
gross income from the property, see Sec. 1.613-6.
    (5) A taxpayer who claims a total deduction of more than $200 for 
depletion of mines, oil and gas wells, or other natural deposits for the 
taxable year ending on or after December 31, 1967, and before December 
31, 1968, shall submit with his return for such taxable year a filled-
out Form M (Mines and Other Natural Deposits-- Depletion Data) or Form O 
(Oil and Gas Depletion Data). See section 6011(a). For the purpose of 
this subparagraph, the determination under section 631(c) of gain or 
loss upon the disposition of coal or domestic iron ore with a retained 
economic interest shall not be regarded as the claiming of a deduction 
for depletion. Such forms shall be filed for any subsequent taxable year 
if the Commissioner determines that the forms are required for such 
year. Where appropriate, both Form M and Form O shall be filed. Forms M 
and O shall be deemed to be part of the return to which they relate. If 
a taxpayer mines more than one mineral, a separate Form M shall be filed 
for each such mineral. If a taxpayer has both domestic and foreign 
properties, separate forms shall be filed for each country in which a 
taxpayer's properties are located. All data relating to a taxpayer's 
domestic oil and gas properties shall be summarized on a single Form O, 
and data relating to a taxpayer's domestic mineral properties (other 
than oil and gas properties) shall be summarized on a single Form M for 
each mineral.

[[Page 400]]

Similarly, all data relating to a taxpayer's oil and gas properties in a 
specific foreign country shall be summarized on a single Form O, and 
data relating to a taxpayer's mineral properties (other than oil and gas 
properties) in a specific foreign country shall be summarized on a 
single Form M for each mineral. In addition, the taxpayer shall 
assemble, segregate, and have readily available at his principal place 
of business, the data listed in subparagraphs (2), (3), and (4) of this 
paragraph.

[T.D. 6500, 25 FR 11737, Nov. 26, 1960, as amended by T.D. 6938, 32 FR 
17518, Dec. 7, 1967; T.D. 7170, 37 FR 5373, Mar. 15, 1972]