Tax Tips for Oil and Gas Working Interest Limited Partners

The Problem:

On your 1040 tax return, it's easy to see where to put the depletion for a royalty owned by a limited partnership, but what about the depletion on a working interest (ordinary business income) for a limited partnership? It says all over the 1065 form not to put it on the partnership form, but there doesn't seem to be any place on the form 1040 Sched E back side or on the Sched SE to subtract the depletion.

Our questions/solutions so far:


-------Original Message-------

From: Nancy Drew Girl Sleuth
Date: 03/11/08 22:50:13
To: Stargazer
Cc: Meself
Subject: Halleluia, I figured OUT SCHEDS E and SE DEPLETION REPORTING METHOD

I found the right fine print tonight to explain what to do on Sched E and
Sched SE. See below and attachments.

On Sched E Part II Line 28, they want you to write in the word depletion in col a on a line
(line B for example) under the line where you stated the business income
(line A for example), and then show the depletion in the loss column or  in < > in the same column as income, I guess (for passive or active). R&D's accountant didn't show it on their return in the loss column, he just subtracted it from the gain column, but now we know what the IRS wants on the back of Sched E. It either goes in the loss column or as a credit in the gain column, not sure.

ON Schedule SE, they want you to subtract the depletion before entering the
amt reported on K-1 Box 14 A, and enter the result on Sched SE. Also attach
an EXPLANATION of what you deducted.

THE COMPUTER DEDUCTION
Now we need to think about that schedule 179 deduction, which pertains to
property used in a trade or business. If the partnership deducts the
computer, does that mean that only the general partner can take her 2%
percentage of the deduction, because she is active in the business? Or can
the passive partners also take their 19.6% of the deduction?

I don't think you can deduct sched 179 stuff from royalties on a personal return (which are passive income, although you can take depletion). However a partnership deducting a shared business expense from business income is something different.

Then there's something on Sched E, PII, line 27, a check box for
"unreimbursed partnership expenses," but they have to be ordinary and
necessary expenses that are required in the partnership agreement.

Maybe we should ask the IRS the answer on this one.


========== from IRS instructions
SCHEDULE E:
see attached SCHED E Part II line 28 instructions (attached with yellow
highlighting and copied below):

Line 28
For nonpassive income or loss (and passive
income or losses for which you are not
filing Form 8582), enter in the applicable
column of line 28 your current year ordi-
nary income or loss from the partnership or
S corporation. Report each related item re-
quired to be reported on Schedule E (in-
cluding ITEMS OF INCOME OR LOSS stated
separately on Schedule K-1) in the applica-
ble column of A SEPARATE LINE following the
line on which you reported the current year
ordinary income or loss. Also enter a
DESCRIPTION of the related item (for exam-
ple, DEPLETION) in column (a) of the same
line.
If you are required to file Form 8582,
see the Instructions for Form 8582 before
completing Schedule E.

======== from IRS instructions
SCHED SE
and see attached SCHED SE INSTRUCTIONS (attached with yellow highlighting
and copied below):

Partnership Income or Loss
If you were a general or limited partner in a
partnership, include on line 1 or line 2,
whichever applies, the amount of net earn
ings from self-employment from Schedule
K-1 (Form 1065), box 14, code A, and
Schedule K-1 (Form 1065-B), box 9, code
J1. GENERAL PARTNERS should REDUCE THIS
AMOUNT BEFORE ENTERING IT on Schedule SE
by any section 179 expense deduction
claimed, unreimbursed partnership ex
penses claimed, and DEPLETION claimed on
oil and gas properties. If you reduce the
amount you enter on Schedule SE, ATTACH
AN EXPLANATION.

and if your SE income is less than 1733, you can use the non farm method
optional method (but you can only ever use this method five times in your
life):

Nonfarm Optional Method. You may use this method only if (a) your net
nonfarm profits 3[[Sch. K-1 (Form 1065), box 14, code A] were less
than $1,733 and also less than 72.189% of your gross nonfarm income,4[Sch.
K-1 (Form 1065), box 14, code C] and (b) you had net earnings
from self-employment of at least $400 in 2 of the prior 3 years.
Caution. You may use this method no more than five times.

========== from IRS instructions
SCHED K-1:
(also appears in 1065 Sched K-1 instructions):

Box 14. Self-Employment
Earnings (Loss)
If you and your spouse are both partners,
each of you must complete and file your
own Schedule SE (Form 1040),
Self-Employment Tax, to report your
partnership net earnings (loss) from
self-employment.
Code A. Net earnings (loss) from
self-employment. If you are a GENERAL
PARTNER, REDUCE THIS AMOUNT BEFORE ENTERING
IT on Schedule SE (Form 1040) by any
SECTION 179 EXPENSE DEDUCTION claimed,
unreimbursed partnership expenses
claimed, and DEPLETION claimed on oil and
gas properties. Do not reduce net earnings
from self-employment by any separately
stated deduction for health insurance
expenses.
If the amount on this line is a loss, enter
only the deductible amount on Schedule SE
(Form 1040). See Limitations on Losses,
Deductions, and Credits beginning on page
2.

Code C. Gross non-farm income. If you
are an individual partner, use this amount to
figure net earnings from self-employment
under the nonfarm OPTIONAL METHOD on
Schedule SE (Form 1040), Section B, Part
II.

========= from IRS instructions
SCHED E, UNREEMBURSED PARTNERSHIP EXPENSES:

Line 27
If you answered “Yes” on line 27, follow
the instructions below. If you fail to follow
these instructions, the IRS may send you a
notice of additional tax due because the
amounts reported by the partnership or S
corporation on Schedule K-1 do not match
the amounts you reported on your tax re-
turn.

Unreimbursed Partnership
Expenses
• You can deduct unreimbursed ORDINARY
and NECESSARY partnership expenses
you paid on behalf of the partnership on
Schedule E IF you were REQUIRED to pay
these expenses UNDER the partnership AGREE-
ment (except amounts deductible only as
itemized deductions, which you must enter
on Schedule A).
• Enter unreimbursed partnership expenses
from nonpassive activities on a sep-
arate line in column (h) of line 28. Do not
combine these expenses with, or net them
against, any other amounts from the part-
nership.
• If the expenses are from a passive ac-
tivity and you are not required to file Form
8582, enter the expenses related to a pas
sive activity on a separate line in column (f)
of line 28. Do not combine these expenses
with, or net them against, any other
amounts from the partnership.
• Enter “UPE” (unreimbursed partnership
expenses) in column (a) of the same
line.


-----Original Message-----
From: Stargazer
Sent: Wednesday, March 12, 2008 12:22 AM
To: Nancy Drew Girl Sleuth
Subject: Re: Halleluia, I figured OUT SCHEDS E and SE DEPLETION REPORTING METHOD


Great find! You're quite the sleuth. I'll try to call the IRS about the schedule 179 deduction, if not tomorrow, then Friday.

-----Original Message-----
From: Nancy Drew Girl Sleuth
Sent: Wednesday, March 12, 2008 12:42 AM
To: Stargazer
Subject: RE: Halleluia, I figured OUT SCHEDS E and SE DEPLETION REPORTING METHOD

on rereading what I wrote, I think we put the depletion stuff in the passive or non passive loss column rather than as a credit on the gain column on the back of schedule E Part II, Line 28. At least that's the column where they tell you to put the UPE expenses. But I'm still not sure.

On the section 179 item, I understand the IRS helper told you that, in our case, each partner, general or limited, can take his or her proportionate percentage on their personal return. So I guess they put it on their 4562 form and write "from partnership" in column A description. I think the partnership also files a 4562 form with the form 1065. But where do the limited partners put the 179 deduction on the back of sched E? There's no special box for it, Does it go in the passive loss column with a note that says section 179 in column A? Another question for the IRS.

-----Original Message-----
From: Nancy Drew Girl Sleuth
Sent: Tuesday, March 25, 2008 7:39PM
To: Stargazer
Subject: RE: Halleluia, I figured OUT SCHEDS E and SE DEPLETION REPORTING METHOD

After talking to M, who is using Turbo Tax, it won't let her claim a percentage of the section 179 as a passive partner on her Sched E part II for an oil and gas working interest limited partnership, even though the IRS help person told you that we could.

That just leaves the depreciation method on page 1, business income, of the 1065, deducted from the whole partnership income before you go to the partner's distributed income/deductions on page 3 of the 1065 return. And by the time you finished depreciating it over 3 or 5 years and divide that savings by your share of the partnership, why bother? It would barely affect anyone's bottom line on their personal tax return in any given year.