How to Report Oil and Gas Depletion from a K-1

To report oil and gas depletion from a K-1, take the figures the partnership gives you in Box 20 Code T, run two separate calculations (cost depletion and percentage depletion), claim whichever produces the larger deduction after applying the statutory limits, and enter the result on Schedule E as a deduction against the partnership income shown on your K-1. The partnership does not do this math for you, and the deduction reduces both your outside basis in the partnership and the property’s basis for future recapture purposes.

Where the Numbers Live on the K-1

The information you need sits in Box 20 under Code T, which the IRS labels “Depletion information — oil and gas.” It reports your share of gross income from the property, your share of production for the tax year, and the other data required to figure depletion.¹ The partnership should also allocate your share of the adjusted basis of each property.

Most of the usable detail comes on a supplemental statement attached to the K-1 rather than in the numbered boxes. Look for a schedule that breaks out, property by property: gross income, operating deductions, your share of units sold (barrels of oil or MCF of gas), total estimated recoverable units, and your allocated adjusted basis. If the statement is missing or incomplete, ask the partnership’s tax department for it before you file. You cannot compute depletion without those figures.

Box 17 matters separately, for alternative minimum tax. Codes D and E report gross income from, and deductions allocable to, oil, gas, and geothermal properties, and they feed Form 6251 rather than your regular depletion calculation.¹

Calculating Cost Depletion

Cost depletion recovers your actual investment as the reserves are produced. Three inputs go into it:

Adjusted basis. Your remaining capital in the property, reduced by all prior years’ depletion deductions.
Total recoverable units. The units still economically recoverable at the start of the year plus the units sold during the year. Section 611 requires this estimate to be revised when new information from operations or development changes the picture.²
Units sold during the year. Your share of production actually sold, not merely produced.

Divide adjusted basis by total recoverable units to get a per-unit rate, then multiply by units sold. Adjusted basis of $50,000, total recoverable units of 25,000 barrels, and 2,000 barrels sold produces cost depletion of $4,000. Once adjusted basis reaches zero for a property, cost depletion for that property stops.

Calculating Percentage Depletion

Percentage depletion ignores your investment entirely and deducts 15% of gross income from the property.³ Because it is not tied to basis, it can keep producing deductions after you have fully recovered your original cost, and lifetime deductions can exceed what you paid.

Take the gross income from the Box 20 Code T supplemental statement and multiply by 15%. On $30,000 of gross income, the preliminary figure is $4,500. Three limits then apply.

100% of Net Property Income

Percentage depletion on any single property cannot exceed 100% of the taxable income from that property, calculated before the depletion deduction.⁴ If a property generated $30,000 of gross income but $28,000 of operating expenses, percentage depletion for that property is capped at $2,000.

1,000 Barrels Per Day

Percentage depletion for independent producers and royalty owners is limited to 1,000 barrels of oil equivalent per day of average production, applied across all of your interests combined.³ Most individual K-1 investors will not reach this ceiling, but if you hold positions in several producing partnerships, verify.

65% of Overall Taxable Income

Your total percentage depletion across all oil and gas properties for the year cannot exceed 65% of taxable income figured without the depletion itself, without the Section 199A qualified business income deduction, and without net operating loss carrybacks or capital loss carrybacks.³ This one is aggregate, applied at your individual return level.

Anything disallowed by the 65% cap is not lost. It carries forward to the next year and is treated as percentage depletion allowable then, subject again to the same 65% limit.⁵

Who Cannot Use Percentage Depletion

Percentage depletion on oil and gas is reserved for independent producers and royalty owners. Two categories are excluded. Retailers lose access if you or a related person sells oil, gas, or derived products through retail outlets, unless combined retail gross receipts stay below $5 million for the year.³ Large refiners are also excluded if you or related persons operate refineries with average daily runs above 75,000 barrels. The related-person rules sweep broadly, so business interests held by family members or affiliated entities can disqualify you.

Claiming the Larger of the Two

You must run both methods each year and claim whichever is larger. Section 613 states that the depletion allowance shall never be less than it would be computed without reference to percentage depletion, which makes cost depletion a floor.⁴ Do the comparison property by property. You may end up using percentage depletion on one well and cost depletion on another in the same year. Only the 65% taxable income cap operates across all properties together; every other limit is evaluated at the property level.

Reserve estimates change and commodity prices move, so a property that favored percentage depletion last year can favor cost depletion this year. Do not assume last year’s answer carries.

Passive Activity and At-Risk Screens

Before your depletion deduction lands on the return, two gatekeepers apply.

Under the passive activity rules, oil and gas activities generally produce passive income or loss for limited partners and royalty owners, and losses can only offset other passive income. A working interest held directly or through an entity that does not limit your liability is not treated as a passive activity, so losses (including depletion) from that interest can offset wages and investment income.⁶ Hold the same interest through a limited partnership or LLC and the exception is gone. Once a working interest has produced a non-passive loss in a given year, later net income from the same property is also treated as non-passive.

Under Section 465, oil and gas exploration and development is one of the activities specifically subject to the at-risk rules.⁷ Deductible losses, depletion included, are capped at the amount you have at risk: cash invested plus amounts borrowed for which you are personally liable or have pledged non-activity property as security. Nonrecourse financing and amounts shielded by guarantees or stop-loss arrangements do not count. Each oil and gas property is a separate activity for this purpose, so track the limit well by well.

Where the Deduction Goes on the Return

The final depletion figure goes on Schedule E (Form 1040), which handles income and loss from partnerships, S corporations, and royalties.⁸ Enter it in the deductions column for your K-1 partnership activity, where it reduces the partnership income shown on the K-1. The net Schedule E result flows to Schedule 1 and then to Form 1040.

Attach a statement showing your calculation. For cost depletion, show the adjusted basis, units sold, total estimated recoverable units, and the resulting deduction for each property. For percentage depletion, show the gross income, the 15% figure, and the application of each limitation. Keep organized property-by-property records; they are what you will need if the return is examined and what you will need to compute recapture years from now.

Basis Reduction in the Partnership

Depletion deductions reduce your outside basis in the partnership interest. Under IRC Section 705, a partner’s basis is decreased by the partner’s share of depletion on oil and gas properties, with an offsetting addition for the excess of percentage depletion over the adjusted basis of the depletable property.⁹ The net effect is still a reduction in most cases.

Outside basis matters because it caps the losses you can deduct. If cumulative depletion and other deductions have driven your outside basis toward zero, additional losses may be suspended until you restore basis through contributions or allocated income. A running basis schedule maintained year over year is essential, and losing track is one of the more expensive mistakes at this level.

Recapture When You Sell

Depletion does not vanish at exit. Under Section 1254, gain on the sale of oil and gas property is treated as ordinary income to the extent of previously claimed depletion deductions that reduced the property’s basis.¹⁰ The recapture amount is the lesser of your total Section 1254 costs (depletion deductions that reduced basis, plus intangible drilling cost deductions) or the gain on the sale. It applies even where gain would not otherwise be recognized under other provisions.

If you have claimed percentage depletion for years and lifetime deductions now exceed your original investment, the tax on sale can be substantial, taxed at ordinary rates rather than capital gains rates. Keep lifetime depletion records for each property so you can compute the recapture accurately when you dispose of the interest.

1
Internal Revenue Service. Partners Instructions for Schedule K-1 Form 1065 2025
2
Office of the Law Revision Counsel. 26 USC 611 Allowance of Deduction for Depletion
3
Office of the Law Revision Counsel. 26 USC 613A – Limitations on Percentage Depletion in Case of Oil and Gas Wells
4
Office of the Law Revision Counsel. 26 USC 613 Percentage Depletion
5
eCFR. 26 CFR 1.613A-4 – Limitations on Application of 1.613A-3 Exemption
6
Office of the Law Revision Counsel. 26 USC 469 Passive Activity Losses and Credits Limited
7
Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk
8
Internal Revenue Service. About Schedule E Form 1040 Supplemental Income and Loss
9
Internal Revenue Service. Partners Outside Basis
10
eCFR. 26 CFR 1.1254-1 – Treatment of Gain From Disposition of Natural Resource Recapture Property