10.10 Working Interests in Oil and Gas Wells

Working interests are not treated as passive activities provided your liability is not limited. This is true whether you hold your interest directly or through an entity. As long as you have unlimited liability, the working interest is not a passive activity even if you do not materially participate in the activity. A working interest is one burdened with the financial risk of developing and operating the property, such as a share in tort liability (for example, uninsured losses from a fire); some responsibility to share in additional costs; responsibility for authorizing expenses; receiving periodic reports about drilling, completion, and expected production; and the possession of voting rights and rights to continue operations if the present operator steps out.

Planning Reminder

Limited Liability for Oil or Gas Well

A working interest in an oil or gas well is exempt from the passive activity restrictions if your liability is unlimited. The following forms of loss protection are disregarded and, thus, are not treated as limiting your liability: protection against loss by an indemnification agreement; a stop-loss agreement; insurance; or any similar arrangement or combination of agreements.

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Limited liability.

If you hold a working interest through any of the following entities, the entity is considered to limit your liability and you are subject to the passive loss rules: (1) a limited partnership interest in a partnership in which you are not a general partner; (2) stock in a corporation; or (3) an interest in any entity other than a limited partnership or corporation that, under applicable state law, limits the liability of a holder of such interest for all obligations of the entity to a determinable fixed amount.

Working interests are considered on a well-by-well basis. Rights to overriding royalties or production payments, and contract rights to extract or share in oil and gas profits without liability for a share of production costs, are not working interests.