$95,000$ barrels as the estimated field life reserves at the end of Year $2$ for the $50\%$ interest purchase

at the beginning of Year $2).$

Problems on Cost Depletion

Calculate the cost depletion deduction for each party in the following problems.

In January of Year $1,$ Smith, the landorvner$-$lessor, and Wildcat Willie, the lessee, enter into a standard

oil and gas lease with Smith receiving a bonus of $$300,000$ and retaining a one$-$sixth royalty. Smith

has a basis of $$10,000$ in the mineral estate. At the close of Year $1$ the total estimated reserves for

calculation of depletion are $240,000$ barrels for full field life. During Year $2,$ Willie produces $12,000$

barrels of oil from the lease. Assume that Willie's adjusted basis in the tract is $$305,000($ $$300,000$

attributed to lease bonus and $$5,000$ attributed to legal fees associated with negotiation of the

lease$).$ The total estimated reserves from the tract for the field life at the close of Year $2$ remain

at $240,000$ barrels as the production engineer reserve estimate did not change year$-$to$-$year. The

remaining reserves at the end of Year $2$ for the field life are $228,000$ barrels $(240,000$ barrels

estimated for total field life less the $12,000$ barrels produced in Year $2).$ Assume further that in Years

$1$ and $2$ oil sold for $$20$ a barrel.

Assume in problem $1,$ above, that the production engineer advises Willie that the total field life

reserves for calculation of depletion based on updated analysis should be updated to $480,000$

barrels. Production in Year $3$ is $12,000$ barrels, so based on the new estimate of total field life

reserves the remaining reserves at the end of Year $3$ are $456,000$ barrels $(480,000$ barrels less

production of $24,000,$ leaving $456,000$ as the estimate of remaining filed life reserves at the close of

Year $3).$

In Year $1,$ Wildcat Wilma purchases a $50\%$ operating interest from a lessee for $$10,000.$ There is

no production in Year $1.$ On January $1$ of Year $2,$ Wilma purchases the remaining $50\%$ operating

interest in the same tract for $$5,000$ from a driller who entered into a farmout agreement with the

lessee. At the close of Year $1$ Wilma's production engineers estimate $100,000$ barrels as the total

estimated reserves for field life associated with the $50\%$ operating interest purchased in Year $1,$

and the $100,000$ barrel estimate remains unchanged at the end of Year $2($leaving $95,000$ barrels as

the estimated field life reserves at the end of Year $2$ given production of $5,000$ barrels during Year

$.$ Wilma's production engineers estimate $100,000$ barrels of reserves associated with the $50\%$

interest acquired in Year $2$ as well, and the estimate does not change at the end of Year $2($leaving

What is the effect if Wilma purchased the remaining $50\%$ operating interest on July $1$ of Year $2?$ See

Treas. Reg. $$1\mathrm{.}611-2($a$)(5).$

In Year $1,$ Acme Oil Company, a lessee of an oil and gas tract, subleases the property to Major Oil

Company in exchange for a $20\%$ net profits interest. Acme's adjusted basis in the lease is $$20,000$

and the estimated value of the net profits interest is $$100,000.$ This value represents $50,000$ barrels

of oil. With respect to this net profits interest, assume there is no NPI payment in Year $1$ and a

$$5,000$ NPI payment in year $2.$ Calculate Acme's cost depletion for Year $1$ and Year $2.$

Assume that Wilma acquired a working interest with two deposits for $$15,000$;$$10,000$ was allocated

to Property $1$ and $$5,000$ to Property $2.$ In Year $1,$ assume production of $6,000$ barrels from Property

$1$ and $4,000$ barrels from Property $2.$ Assume total estimated reserves for field life for Property

$1$ are $100,000$ barrels so at the end of Year $1$ the total field life reserves are $94,000$ barrels. Total

estimated reserves for field life for Property $2$ are $80,000$ barrels so at the end of Year $1$ the total

field life reserves are $76,000$ barrels. Combined total estimated field life reserves for Property $1$ and

Property $2$ are $180,000$ barrels so at the end of Year $1$ total field life reserves are $170,000$ barrels.

Should Wilma elect Property $1$ and Property $2$ to be separate properties or make no election and let

the properties be aggregated?

$1$ I.R$.$C$.$ $$ $611-12,1011(2012).$

$2_{?}$ Treas. Reg. $$$1\mathrm{.}611-0$ to $-3,1\mathrm{.}612-3,-3.$

$2$ Clemente, Inc. v$.$ Comm'r, T$.$C$.$ Memo $1985-367(1985).$

$3_{?}$ See U$.$S$.$ Securit