How is the excess of percentage depletion over adjusted basis treated?

The excess of percentage depletion over the adjusted basis is treated as income for tax purposes. This treatment is established under Section 611 of the Internal Revenue Code, which states that when the allowable percentage depletion exceeds the adjusted basis of the property, the excess must be reported as income in the year it occurs.

Essentially, percentage depletion allows a taxpayer to recover a portion of their investment in a natural resource, based on a percentage of the income generated from that resource. If the percentage depletion calculation yields an amount greater than the taxpayer's remaining basis in the asset, this excess is not a mere reduction in basis but rather is recognized as taxable income.

This approach aligns with the principle that taxpayers should report all income earned, including economic benefits realized from tax provisions like depletion deductions. Recognizing this excess as income ensures that taxpayers do not benefit excessively from tax deductions more than their actual investment in the resource reflects, thereby maintaining fairness and integrity in the tax system.