Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 65-10

1965-1 C.B. 254

IRS Headnote

Taxpayers may use either the `sum of the dollars' method or the `decline in principal' method in computing cost depletion on mineral production payments which contain an interest equivalent element.

Full Text

Rev. Rul. 65-10 /1/

Advice has been requested concerning the computation of cost depletion, under section 611 of the Internal Revenue Code of 1954, on mineral production payments which contain an `interest equivalent element.'

Mineral production payments of this type entitle the owner thereof to receive a stated sum, known as `principal,' plus an amount known as an `interest equivalent element.' The `interest equivalent element' is computed periodically and is equal to a specific percentage of the unliquidated principal balance. Both the `principal' and the `interest equivalent element' are payable solely out of a specified fraction of production from the mineral property.

Two methods for computing cost depletion on production payments with `interest equivalent elements' are presently being used. The first, known as the `sum of the dollars' method, is computed by multiplying the basis of the production payment at the end of the year (before adjustment for depletion) by a fraction, the numerator of which is the total proceeds received from the production payment during the taxable year and the denominator of which is the total expected amount remaining to be recovered from the production payment at the beginning of the year. The second method, known as the `decline in principal' method, is computed by multiplying the basis of the production payment at the end of the year by a fraction, the numerator of which is the portion of the proceeds from the production payment received during the taxable applied against the principal (excluding the `interest equivalent element') and the denominator of which is the principal balance of the production payment at the beginning of the year (with the total estimated `interest equivalent element' excluded).

Uncertainty has arisen as to the acceptability of either method since no published position has been taken in this matter. As a result, the disposition of cases involving this issue has remained unsettled.

In order to facilitate settlement of these cases, a taxpayer may continue to use the method adopted with respect to each separate production payment in returns filed before December 18, 1964. Moreover, for the time being, a taxpayer may elect either of the above methods for each production payment acquired in a taxable year for which a return has not been filed. Once the election is made, it may be changed only with the consent of the Commissioner of Internal Revenue. Should the option afforded herein be modified, only production payments acquired after the date of modification will be affected.

/1/ Also released as Technical Information Release 668, dated Dec. 18, 1964.