Can individuals reduce their income from other sources with deductions generated by ventures that own oil and gas working interests?
Generally yes, because the deductions generated by our venturers’ oil and gas working interests are not treated as “passive losses.” The Tax Reform Act of 1986 provides that, in most cases, deductions generated after 1986 from investments in which an individual does not materially participate are treated as “passive losses” and can be deducted only against “passive income”. Deductions classified as “passive losses” cannot offset income such as wages, interest, or income from many businesses in which the individual materially participates. However, the law contains an exception, Section 469(c)(3), under which, among other things, deductions generated by oil and gas working interests (as opposed to royalty interests) owned through general partnerships are not considered “passive losses,” so partners and joint venturers can deduct these losses against their income from other sources. Similarly, any income subsequently generated by such ventures will not be treated as “passive income.
