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Excess percentage depletion AMT - what does property mean?

The Federal Circuit Court of Appeals recently held in Hill, Fed. Cir., 9/11/91, aff'g Cl. Ct., 1990, that the tax preference item defined by old Sec. 57(a)(8) (currently Sec. 57(a)(1)) as in force during 1981 and 1982 did not produce a tax preference item until the oil and gas percentage depletion exceeded both the depletable and depreciable bases of the producing property. The IRS unsuccessfully contended that property meant only depletable property, so that the adjusted basis of lease and well equipment could not be used in determining whether excess depletion had occurred.

The adjusted current earnings (ACE) adjustment under Sec. 56(g)(4)(5) permits only a cost depletion deduction. Accordingly, 75% of the excess of percentage depletion over cost depletion will be subject to the alternative minimum tax (AMT).

The Hill decision will be of particular interest to coal and hardrock mining operators who frequently have large property aggregations usually based on the operating unit, as well as significant expenditures for mining equipment. Application of the Hill decision to these mining operations will defer the imposition of the AMT on excess percentage depletion, particularly if additions are being made to the property unit. However, as noted, the ACE adjustment must be considered.

It appears that the Service's position cannot be supported unless the Code and the regulations are changed. Also to be considered is IRS Letter Ruling 9126009, which explained that a separate AMT computation must be made for the AMT basis (as compared to the regular basis) of a mineral property.

Specifically, Letter Ruling 9126009 provided guidance on the adjustments to AMT basis for percentage depletion when mineral interests were aggregated into a single property. The adjusted basis of the resulting aggregate property is the unadjusted basis of the aggregate property, adjusted by all the basis adjustments of the component mineral interests required by Sec. 1016 to the date of the aggregation. Although depletion is an adjustment under Sec. 1016, and percentage depletion allowances may exceed the adjusted basis, for purposes of computing gain on the sale of a mineral property, the adjusted basis cannot be reduced below zero.

However, the IRS noted that any percentage depletion allowed or allowable after adjusted basis is reduced to zero will be applied against any subsequent additions to the capital account under Rev. Rul. 75-451. That is, percentage depletion in excess of basis must be netted against any new aggregation in determining the adjusted basis of newly aggregated mineral property. Affected taxpayers should consider refund claims. Note: The Federal Circuit recently approved a motion to rehear Hill.
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Author:Dutt, Wayne E.
Publication:The Tax Adviser
Date:Jan 1, 1992
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