Ttb

[veritas]

Page 7-4 dealing with working interest in oil or gas property.

"A working interest in an oil or gas well held directly, or through an entity that did (does?) not limit liability, is not a passive activity even if the taxpayer did not materially participate. Report income and expenses on Form 1040, Schedules C and SE."

I have a K-1 from an entity that did (does) not limit liability. Why would this go on a Schedule C?

[DexEA]

Another stupid question:

What is a "working interest" in an oil or gas well?

[Bees Knees]

IRC §469(c)(3)(A)

The term passive activity shall not include any working interest in any oil or gas property which the taxpayer holds directly or through an entity which does not limit the liability of the taxpayer with respect to such interest.

Schedule C instructions, page 4, Line G instructions:

Exception for oil and gas. If you are filing Schedule C to report income and deductions from an oil or gas well in which you own a working interest directly or through an entity that does not limit your liability, check the “Yes” box. The activity of owning a working interest is not a passive activity, regardless of your participation.

Schedule E instructions, page 3

A working interest in an oil or gas well you held directly or through an entity that did not limit your liability is not a passive activity even if you did not materially participate.

Royalty income not derived in the ordinary course of a trade or business reported on Schedule E in most cases is not considered income from a passive activity.

A working interest in an oil or gas activity where your liability is not limited is a non-passive activity, regardless of material participation and regardless of whether it is through an entity or held directly. Thus, passive activity loss limitations do not apply.

As to whether it is reported on a Schedule C or on Schedule E as royalty income depends on whether or not the income was derived in the ordinary course of a trade or business. I can’t imagine a scenario where an oil or gas operation is not a trade or business. Usually oil or gas is extracted from the ground by a company that is operating as a business. But I suppose anything is possible.

If it is a business doing the pumping – Royalties go on Schedule C
If it is not a business doing the pumping – Royalties go on Schedule E

[Bees Knees]

Keep in mind, we are talking about owning an interest in a company doing the pumping.

If you are the land owner, and a company that you do not own is paying you royalties to extract oil or gas from your property, you do not own a working interest in an oil or gas well. Report royalty income on Schedule E because you do not have an ownership interest in the company doing the pumping.

[DexEA]

Keep in mind, we are talking about owning an interest in a company doing the pumping.

If you are the land owner, and a company that you do not own is paying you royalties to extract oil or gas from your property, you do not own a working interest in an oil or gas well. Report royalty income on Schedule E because you do not have an ownership interest in the company doing the pumping.

Thanks Bees Knees, that answers my question.

[Bees Knees]

I found this explanation of what a working interest is by doing a google search:

The landowner owns the mineral rights and signs a lease that gives him a 20% royalty. The oil company drills and finds oil and produces it. The landowner owns 20% of the net revenue interest, so he receives 20% of the revenues.The oil company owns 100% of the working interest, thus pays for 100% of all expenses. However, the oil company only has 80% of the net revenue interest.

So the term "working interest" refers to the one who pays all the expenses to extract the oil or gas from the ground. That then gives the working interest a right to some of the oil and gas revenues.

In contrast, the land owner owns a revenue interest, meaning he/she is entitled to some of the oil and gas revenues that the oil company produces without having to incur any expense.

This also explains why a working interest activity would be a Schedule C activity, in contrast to a revenue interest being a Schedule E activity. Schedule E is for real estate activities. If you are a land owner receiving oil and gas royalties as a result of someone else pumping oil from your ground, it is a Schedule E activity. If you own a working interest in an oil company, it is a Schedule C activity because it is an ownership interest in a trade or business.

An exception would be if your working interest income and expenses are reported to you on a K-1 through a partnership, which of course is always reported in Part II of Schedule E (with SE tax consequences).

[Burke]

An exception would be if your working interest income and expenses are reported to you on a K-1 through a partnership, which of course is always reported in Part II of Schedule E (with SE tax consequences).

THAT's what I was waiting for in this thread. Was getting ready to pose the question. All my clients involved with this industry are associated only because they own shares in PTP's. Now, because it is this particular industry is it or is it still not considered a passive activity? And all the at-risk, and basis rules apply? And the passive loss rules too? Most have losses, but some have gains. One just came in today with 13 of these things! And they sold 12 of them last year.

[Bees Knees]

All my clients involved with this industry are associated only because they own shares in PTP's. Now, because it is this particular industry is it or is it still not considered a passive activity?

Like I said - where to report, and whether or not it is a passive activity are two separate issues.

A partnership with a K-1 always goes on Schedule E, part II, regardless of whether or not it is a passive activity or non-passive activity.

The passive activity rules state that an oil and gas well operation is an exception to the passive loss limit rules. If you own a working interest (meaning you have an ownership share of all the expenses), then it is automatically a non-passive activity regardless of your participation in the activity.

The key, however, is that in order for this exception to apply, you can't have limited liability status. Thus, if you own an interest in an oil and gas well through a limited partnership, your liability is limited, and this exception to the passive activity rules does not apply. Any loss would be subject to the passive activity loss limits.

[veritas]

My point was

the wording in TTB needs a little fixing.

[Burke]

Like I said - where to report, and whether or not it is a passive activity are two separate issues.

A partnership with a K-1 always goes on Schedule E, part II, regardless of whether or not it is a passive activity or non-passive activity.

The passive activity rules state that an oil and gas well operation is an exception to the passive loss limit rules. If you own a working interest (meaning you have an ownership share of all the expenses), then it is automatically a non-passive activity regardless of your participation in the activity.

The key, however, is that in order for this exception to apply, you can't have limited liability status. Thus, if you own an interest in an oil and gas well through a limited partnership, your liability is limited, and this exception to the passive activity rules does not apply. Any loss would be subject to the passive activity loss limits.

Thank you so much for clearing that up. My software is treating it exactly right.

[Burke]

The passive activity rules state that an oil and gas well operation is an exception to the passive loss limit rules. If you own a working interest (meaning you have an ownership share of all the expenses), then it is automatically a non-passive activity regardless of your participation in the activity.

I understand this to be true in the case of a working interest. Does the person who holds such a working interest, where liability is not limited, still have to conform to at-risk rules? In other words, can deductions exceed his basis and be taken as losses on the tax return? This would include IDC and depletion deductions.

[Bees Knees]

I understand this to be true in the case of a working interest. Does the person who holds such a working interest, where liability is not limited, still have to conform to at-risk rules? In other words, can deductions exceed his basis and be taken as losses on the tax return? This would include IDC and depletion deductions.

The working interest exception rule is an exception to the passive activity loss limitation rules only. Nothing in the code carries that rule over to basis or at-risk basis calculations.

However, you should be aware of another rule that applies to percentage depletion. TTB page 9-21 says:

Percentage depletion for mineral property. Calculate
percentage depletion by multiplying income for
depletion by the applicable percentage specified
in IRC section 613. Total percentage depletion
claimed on mineral property may exceed the
adjusted basis in the property.

That is because percentage depletion is limited to income from the property. Thus, you have to have income before you can take the deduction, so if there is a loss from the activity, percentage depletion would already be zero regardless of basis.