Oil and gas working interest owner taxes and deductions

This is the widest exception in the passive loss rules and almost nobody outside the industry knows it exists. A working interest in an oil or gas property is not a passive activity however few hours you put into it. So the losses can offset your salary, which a rental property of identical passivity cannot.

The condition is the form of ownership: you must hold it directly or through something that does not limit your liability, such as a general partnership interest. Hold the same well through an LLC or as a limited partner and the exception vanishes. Intangible drilling costs, the labor and services with no salvage value, usually most of a well's cost, can be deducted in the year incurred rather than capitalized, but the election is made on the first return where such costs arise and binds every year after. Say nothing on that first return and you have elected to capitalize, irrevocably. Once losses have been allowed, later income from the same property is recharacterised as non-passive too.

The deductions with a rule attached

These are the lines where the answer is not simply "keep the receipt"each has a cap, a percentage or a test that decides how much of the spend you actually get:

Equipment: Section 179 property. Deduct the whole cost in the year it goes into service rather than spreading it over the asset's life, up to $2,560,000 a year, and 100% bonus depreciation is now permanent. The catch is the business-use test: anything used more than 50% for the business qualifies, and you deduct at that percentage rather than the full price. So anything you also use at home comes off at the share that is genuinely work, not the whole invoice.

The rest of the oil and gas working interest owner deduction list

Ordinary and necessary business expenses, deductible in full in the year you pay them, provided they are genuinely for the business:

Intangible drilling costs
Depletion
Liability insurance
Lease operating costs
Professional fees
Permits and licenses
Reclamation costs

Worth knowing

A working interest is excluded from the passive loss rules entirely, which no other investment of comparable passivity is.

That is what is specific to this trade. The larger deductions are the universal ones, see the full checklist.

What each deduction is worth to you

On $100,000 of profit with no state income tax, $1,000 deducted saves $305, 30.5%, because it comes off self-employment tax and income tax together:

Net profit	Saved per $1,000 deducted	Effective
$40,000	$231	23.1%
$100,000	$305	30.5%
$200,000	$297	29.7%

The last row is worth less than the one above it, and that is not a mistake: past the Social Security wage base the self-employment part of the saving drops from 15.3% to 2.9%, and the higher income-tax bracket does not quite make up the difference. A deduction is worth most in the middle.

Add a state income tax and every row rises. The 1099 calculator applies that layer.

Where this comes from

The rules on this page that are specific rather than general are cited below. Follow a link to read the provision itself rather than taking our word for it:

A working interest is not a passive activity where the form of ownership does not limit liabilityIRC 469(c)(3)
Intangible drilling costs may be expensed by election, made on the first return and binding thereafterIRC 263(c); Reg. 1.612-4
Percentage depletion is computed on gross income from the propertyIRC 613

What these words mean

Section 179: A rule letting you deduct the whole cost of equipment in the year you start using it, instead of spreading it over the years you own it.
Depreciation: Spreading the cost of something long-lasting, a vehicle, a camera, a tractor, across the years you use it, rather than deducting it all at once.

General information about how these deductions work, not tax advice. Whether a particular expense is deductible for you depends on facts this page does not have, check with a tax professional before claiming anything listed here.