February 6, 2025
Oil and gas royalties might sound complex, but at their core, they’re simply payments you receive when energy companies extract resources from land you have rights to
This article explores how oil and gas royalty owners can reduce their taxable income through depletion deductions. If you receive income from mineral rights, understanding cost and percentage depletion can unlock substantial tax advantages.
You’ll learn when each method applies, how to calculate your deduction, and which IRS forms are required. With Fieldvest, you gain access to curated energy projects that offer income potential. They also enable qualified investors to benefit from immediate tax offsets through structured investment strategies.
Oil and gas royalties might sound complex, but at their core, they’re simply payments you receive when energy companies extract resources from land you have rights to. If you're getting checks in the mail (or plan to), here's how it works, and how to make the most of it.
Think of royalties as your share of the pie. When oil or gas is pulled from the ground, you—as the royalty owner—get a percentage of the revenue from what’s sold. That cut typically ranges from 12.5% to 25%, depending on the lease.
Sometimes, you’ll also get a signing bonus just for agreeing to the lease. That’s upfront cash before a single barrel comes out of the ground.
Bottom line: Royalties offer regular income without you doing any drilling. But to get the most from them, you need to understand your contract.
Your royalty income depends entirely on the terms of your lease. These documents spell out not just your royalty rate, but how long the agreement lasts and whether you’re owed extra payments like bonuses or minimum royalties.
A well-negotiated lease = more money in your pocket and fewer surprises down the road. It also protects your legal rights to the revenue, so you’re paid fairly and on time as production happens.
Good platforms can help here. They connect you to projects with clear terms and vetted operators, making it easier to understand what you’re signing up for.
If you’re earning income from oil and gas royalties, depletion isn’t just a tax term—it’s a tool to keep more of your earnings. The IRS lets you deduct a portion of your revenue because those resources are, well, running out. Here’s how the two main depletion methods work, and when to use each.
The depletion allowance is a tax break for owners of natural resources. It helps you recover the value of the asset as it’s extracted. You have two choices:
Choosing the right one can significantly impact the amount of tax you owe.
Cost depletion is pretty straightforward. It spreads your original investment over the life of the well. Let’s say:
You deduct $20,000 (that’s $20 per unit × 1,000 units). This method is precise, but once you recover your basis, the deductions stop.
With percentage depletion, the IRS lets you write off a flat 15% of your gross royalty income, no matter your cost. So, if your royalty checks total $200,000 this year, your deduction is $30,000.
Here’s why investors like it:
Even after you’ve recovered your entire investment, you can keep deducting 15% year after year, as long as the income keeps flowing.
If you’ve just started receiving royalties and haven’t recovered your costs, cost depletion may give you the bigger break early on. But once you’ve passed that threshold—or if oil prices spike—percentage depletion often wins.
Keep in mind, percentage depletion has caps:
Thoughtful tax planning means knowing when to switch. That’s where a good advisor—or a clear platform—can help.
It’s a fair question—and one that typically gets lost in tax code jargon. To claim depletion deductions, you need to hold an “economic interest” in the mineral property. Translation? You’re earning money from the oil or gas being pulled out of the ground, and you have a legal right to it.
If you’re receiving royalty payments because you own the land or a mineral lease, congratulations: you likely qualify. But here’s the catch: just having an income isn’t enough.
Your property must be producing oil or gas. No production, no deduction. And remember, you can’t deduct more than your income from that property. The IRS doesn’t let you create losses through depletion.
It’s worth taking the time to confirm your ownership status and keep clear records of production. That’s what separates a casual royalty holder from someone who maximizes every tax advantage.
Let’s get practical. Depletion isn’t just a technical term—it’s your chance to shrink your tax bill if you’re earning oil and gas royalties.
Here’s how it works: when you report royalty income, you get to subtract either a portion of your original investment (cost depletion) or a flat 15% of your gross income (percentage depletion). That means less of your royalty check gets taxed.
Example:
That’s real money saved—and potentially a lower tax bracket or smaller exposure to the Net Investment Income Tax. The key is knowing which method applies and keeping your records clean.
If you’re receiving royalty payments, taxes can take a big bite—unless you understand how to manage them. Here’s what to keep in mind:
As we’ve seen, the depletion deduction is your best friend. You can go with:
To claim either one, keep production records, know your income sources, and report them correctly on your tax return.
Pro tip: Watch for Forms 1099-MISC or 1099-NEC from the operator—they show how much you were paid and help track your deduction.
Use Schedule E (Supplemental Income) to report your royalty earnings. It’s where you summarize income and deductions tied to passive investments.
If you’re more hands-on—like owning a working interest—you may need to file Schedule C and deal with self-employment taxes. Always check with a tax advisor.
High earners may face a 3.8% Net Investment Income Tax if their modified adjusted gross income tops $200,000 (or $250,000 if married filing jointly). That’s on top of your regular taxes.
Also, be cautious if you’re receiving income as a business operator—it might trigger self-employment tax, especially if you have control over production or operations.
Fieldvest simplifies this by providing income transparency and vetted investment details, so you’re not left guessing what the IRS will expect.
Royalty statements. Production reports. Tax forms. It’s easy to feel buried under paperwork when managing oil and gas income.
The good news? You don’t have to be a CPA to stay organized.
Start with a simple spreadsheet or digital tool—many investors use QuickBooks or Excel. Track each payment you receive, including the volume of oil or gas sold and the price per unit. That way, when it’s time to calculate cost or percentage depletion, the math is already done.
Some platforms provide performance data and tax-ready reports to make this even easier. The goal is to avoid the year-end scramble—and get every dollar you’re entitled to back at tax time.
If you ever feel overwhelmed, remember: the IRS doesn’t reward guesswork. Consistent, clean records are your best friend.
Oil and gas royalties can feel like mailbox money, but behind the scenes, the type of interest you hold and how you manage costs can make or break your returns.
Let’s break it down in plain English.
Not all oil income is created equal. The kind of stake you hold determines how much you earn and what risks come with it.
There’s also something called an overriding royalty interest, which gives you a slice of income without owning the land or paying the bills. These can be appealing for investors who want upside without heavy involvement.
Understanding the difference helps you choose investments that fit your financial goals and tolerance for complexity.
Every dollar you invest or spend on oil operations impacts your bottom line. That’s where cost recovery comes in.
When you recover your capital through production income and depletion deductions, you boost profitability and lower your tax exposure. It’s a powerful combo.
But don’t forget the ongoing costs:
Keep a close eye on your financials. Reviewing project reports and expense statements regularly gives you a sharper view of your margins—and helps you act fast if something’s off..
Oil and gas royalties offer powerful tax advantages—but they also come with complex rules. Knowing how and when to apply depletion deductions can help you reduce tax burdens and enhance after-tax returns.
Fieldvest connects accredited investors to energy projects where these strategies apply in practice. Whether you’re optimizing deductions through percentage depletion or planning income across multiple assets, the right platform makes execution easier.
Explore opportunities with potential for steady revenue and immediate tax relief. See how they can help you make smarter use of your royalty income today.
It depends on the method you use.
Whichever gives you the bigger deduction is the one to go with.
The IRS lets you choose cost or percentage depletion.
But there are limits. For example, you can’t deduct more than your net income from the property, and there’s a cap at 65% of your total taxable income.
Usually when:
That’s when the 15% flat-rate deduction can really shine.
Yes, as long as you have an economic interest in the oil or gas property, meaning you earn a share of production revenue. If you're getting paid for extracted minerals, you likely qualify.
Track:
You’ll need this to calculate your deduction and file correctly with the IRS.
Absolutely. A $30,000 depletion deduction on $150,000 in royalties could bring your taxable income down to $120,000, which may even move you into a lower tax bracket.