Revenue Procedure 2004-19 - Probable or Prospective Reserves Safe Harbor

IRS, Rev. Proc. 2004-19, 2004-10 I.R.B. 563

Department of the Treasury
Internal Revenue Service
Revenue Procedure
•

REV. PROC. 2004-19, 2004-10 I.R.B. 563 (3/8/2004)
Section 611--Allowance of Deduction for Depletion
26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement; determination of
correct tax liability.
(Also Part I, sections 611; 1.611-2.)
Rev. Proc. 2004-19
SECTION 1. PURPOSE
This revenue procedure provides an elective safe harbor that the owner of an oil and gas property may
use in determining the property's recoverable reserves for purposes of computing cost depletion under
section 611 of the Internal Revenue Code.
SECTION 2. BACKGROUND
.01 In General. Section 611(a) and the regulations thereunder allow as a deduction in computing
taxable income a reasonable allowance for depletion in the case of oil and gas wells according to the
peculiar conditions in each case.
.02 Computation of Cost Depletion. Under section 1.611-2(a) of the Income Tax Regulations, a
taxpayer claiming the deduction for cost depletion computes the amount allowed with respect to each
oil and gas property by reference to both the total number of recoverable units that the property is
estimated to contain and the number of units sold from the property during the taxable year.
.03 Depletion Accounts. A taxpayer is required under section 1.611-2(b) to keep accounts for the
depletion of each property and to adjust those accounts annually for units sold and for depletion
claimed.
.04 Reserve Estimates. Section 1.611-2(c)(1) contains the rules for estimating the total recoverable
units of mineral products reasonably known, or on good evidence believed, to exist with respect to
each property. The estimate or determination must be made according to the method current in the
industry and in light of the most accurate and reliable information obtainable. Under the regulations,
the estimate of total recoverable units includes all reserves that are proved and, under appropriate
circumstances, probable or prospective reserves in addition to the reserves that are proved.
05 Revisions of Reserve Estimates.
(1) Under section 1.611-2(c)(2), if the number of recoverable units of mineral in the deposit has been
previously estimated, and if there has been no known change in the facts upon which the prior
estimate was based, the number of recoverable units of mineral in the deposit as of the taxable year
will be the number remaining from the prior estimate. However, section 611 provides that, in any case
in which it is ascertained as a result of operations and development work that the recoverable units are
greater or less than the prior estimate, then the estimate will be revised and the revised estimate will
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IRS, Rev. Proc. 2004-19, 2004-10 I.R.B. 563

be used for subsequent periods. Under section 1.611-2(c)(2), a revision is made only when operations
or development work indicates that the remaining recoverable units as of the taxable year are
materially greater or less than the number remaining from the prior estimate. The revised estimate is
used until a change in facts requires another revision.
(2) In Martin Marietta Corporation v. United States, 7 Cl. Ct. 586 (1985), the United States Claims
Court interpreted section 611(a) and section 1.611-2(c)(2) as intended to remedy mistakes of
geological fact: situations where the actual size of the mineral deposit in place, as originally estimated,
is later determined on the basis of more exploratory studies, for example, to be greater or less than
earlier information indicated. The court distinguished situations where revisions are made under the
statute and regulations from those in which the mineral property has experienced a mere diminution in
value or even a retreat into worthlessness.
.06 Differences between Tax and Financial Accounting for Reserves. Generally, accounting for
reserves for purposes of the depletion allowance differs from accounting for reserves for financial
purposes in two important respects. First, while the regulations require the inclusion of probable or
prospective reserves in addition to proved reserves for purposes of the depletion allowance, the United
States Securities and Exchange Commission (SEC) generally requires the reporting of only proved
reserves for financial purposes. Second, the revision of a reserve estimate for purposes of the
depletion allowance is permitted under fewer circumstances than is the revision of a reserve estimate
for financial reporting purposes. While the SEC may require or permit the revision of a reserve
estimate in the case of changes in the price of the mineral or the cost of its extraction, such
circumstances are not sufficient basis for revision of a reserve estimate for purposes of the depletion
allowance.
.07 Probable or Prospective Reserves. The appropriate quantity of probable or prospective reserves to
be included in an oil and gas property's total recoverable units for purposes of computing cost
depletion has been a source of controversy between taxpayers and the Service. When present, the
issue has been resolved through the examinations which are costly for both parties in the dispute. This
revenue procedure provides a safe harbor which is intended to remove this source of controversy from
the examinations of taxpayers who elect it.
SECTION 3. SCOPE
.01 In General. A taxpayer's estimate of an oil and gas property's probable or prospective reserves
determined under the safe harbor provided in this revenue procedure may be used only for purposes
of the depletion allowance. This revenue procedure has no application to the determination of the fair
market value of any oil and gas property or for any other purpose not specifically authorized herein.
.02 Effect of Other Statutory and Regulatory Rules. Except with respect to estimated total recoverable
units (within the meaning of section 1.611-2(c)(1)) and revised estimates (within the meaning of
section 1.611-2(c)(2)), this revenue procedure has no effect on the rules provided in section 611 and
the regulations thereunder.
SECTION 4. TOTAL RECOVERABLE UNITS SAFE HARBOR
.01 If a taxpayer makes an election in accordance with section 5 of this revenue procedure, then, for
purposes of computing cost depletion:
(1) The total recoverable units under section 1.611-2(c)(1) that each of the taxpayer's domestic oil and
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IRS, Rev. Proc. 2004-19, 2004-10 I.R.B. 563

gas producing properties is estimated to contain as of a specific date will be treated as being equal to
105 percent of the property's “proved reserves” (both developed and undeveloped) as defined in 17
C.F.R. section 210.4-10(a) of Regulation S-X, as of that date;
(2) The total recoverable units under section 1.611-2(c)(2) that each of the taxpayer's domestic oil and
gas producing properties is estimated, on a revised basis, to contain as of a taxable year will be
deemed to be equal to 105 percent of the property's “proved reserves” (both developed and
undeveloped) as defined in Regulation S-X, as of that taxable year.
.02 Nothing in this revenue procedure precludes the examination and adjustment, if appropriate, of the
estimate of proved reserves, as defined in Regulation S-X, in order to ensure that this revenue
procedure is properly administered. Except as provided in section 5.02 of this revenue procedure, a
taxpayer's estimate of a property's remaining recoverable units may be revised only under the
circumstances permitted under section 1.611-2(c)(2).
SECTION 5. METHOD OF ELECTION AND REVOCATION
.01 In General.
(1) Election. To elect the safe harbor provided in this revenue procedure for taxable years ending on or
after March 8, 2004, a taxpayer must attach a statement to its timely filed (including extensions)
original federal income tax return for the first taxable year for which the safe harbor is elected. The
statement must indicate that the taxpayer is electing the safe harbor provided by Rev. Proc. 2004-19,
and include the taxpayer's name, address, taxpayer identification number, and contact name and
telephone number. A copy of the statement must be sent to the Industry Director, Large and Mid-Size
Business, Natural Resources, 1919 Smith Street, HOU 1000, Houston, Texas 77002. Once a taxpayer
files a first return electing the safe harbor for a taxable year, the taxpayer may not revoke the election
for the taxable year. The election is effective for the taxable year of election and all subsequent taxable
years until revoked and applies to all of the taxpayer's domestic oil and gas producing properties.
(2) Revocation. To revoke a safe harbor election, a taxpayer must attach a statement to its timely filed
(including extensions) original federal income tax return for the first taxable year for which the safe
harbor is revoked. The statement must indicate that the taxpayer is revoking the safe harbor provided
by Rev. Proc. 2004-19, and include the taxpayer's name, address, taxpayer identification number, and
contact name and telephone number. A copy of the statement must be sent to the Industry Director,
Large and Mid-Size Business, Natural Resources, 1919 Smith Street, HOU 1000, Houston, Texas
77002. If a taxpayer revokes its election, the taxpayer may not re-elect the safe harbor for the next five
taxable years following the taxable year of revocation.
.02 Election of Safe Harbor for Taxable Year Beginning Before January 1, 2005. If the first taxable
year for which a taxpayer elects the safe harbor provided in this revenue procedure begins before
January 1, 2005, the taxpayer may, for the taxable year of election, revise the estimate of remaining
recoverable units for any of the taxpayer's domestic oil and gas producing properties whether or not
there has been a change in geological fact indicating that the remaining recoverable units as of the
taxable year for any given property is materially greater or less than the number remaining from the
prior estimate. The taxpayer must use the economic and operating conditions (such as prices and
costs) applicable to the taxable year of election in determining the estimate of total recoverable units.
.03 Election of Safe Harbor for Taxable Year Beginning After December 31, 2004. If the first taxable

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IRS, Rev. Proc. 2004-19, 2004-10 I.R.B. 563

year for which a taxpayer elects the safe harbor provided in this revenue procedure begins after
December 31, 2004, the taxpayer must determine, for each domestic oil and gas producing property,
the last taxable year preceding the taxable year of election as of which the taxpayer revised an oil and
gas property's total recoverable units (the year of last revision) pursuant to section 1.611-2(c)(2). The
taxpayer determines the property's remaining recoverable units for the year of last revision using the
safe harbor rules set forth in section 4 of this revenue procedure. The taxpayer then applies the rules
set forth in section 1.611-2(b) for all subsequent taxable years to determine the property's remaining
recoverable units for the taxable year of election. Similar procedures apply if the taxpayer's estimate of
the property's remaining recoverable units is based on the taxpayer's original estimate of its total
recoverable units under section 1.611-2(c)(1). The taxpayer may not, for the taxable year of election,
revise the estimate of remaining recoverable units for any of the taxpayer's domestic oil and gas
producing properties unless there has been a change in geological fact indicating that the remaining
recoverable units as of the taxable year for any given property is materially greater or less than the
number remaining from the prior estimate.
SECTION 6. EFFECTIVE DATE
This revenue procedure is effective for taxable years ending on or after March 8, 2004.
SECTION 7. PAPERWORK REDUCTION ACT
The collection of information contained in this revenue procedure has been reviewed and approved by
the Office of Management and Budget in accordance with the Paperwork Reduction Act ( 44 U.S.C.
section 3507) under control number 1545-1861.
An agency may not conduct or sponsor, and a person is not required to respond to, a collection of
information unless the collection of information displays a valid OMB control number.
The collection of information in this revenue procedure is in section 5. The information in section 5 is
required to be submitted to the applicable service center in order to elect (or revoke) the safe harbor.
This information will be used to determine whether a taxpayer estimated the total recoverable units for
each of its domestic oil and gas producing properties under the safe harbor. The likely respondents
are businesses or other for-profit institutions.
The estimated total annual reporting burden is 50 hours.
The estimated annual burden per respondent varies from .25 hours to .75 hours, depending on
individual circumstances, with an estimated average burden of .5 hours to complete the statement.
The estimated number of respondents is 100.
The estimated annual frequency of responses is on occasion.
Books or records relating to a collection of information must be retained as long as their contents may
become material in the administration of any internal revenue law. Generally, tax returns and tax return
information are confidential under 26 U.S.C. section 6103.
SECTION 8. DRAFTING INFORMATION
The principal author of this revenue procedure is Jolene J. Shiraishi of the Office of the Associate
Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue
procedure, contact Ms. Shiraishi at (202) 622-3120 (not a toll-free call).
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