Oil & Gas Working Interests

Of the private asset classes, this one has the widest gap between how it’s marketed and how it works. The marketing leads with tax treatment. The structure leads with liability.

Working Interest vs Royalty Interest

A working interest is an ownership stake in the operation of a well. You get a share of production revenue and a share of the costs — drilling, completion, operating expenses, workovers, and eventually plugging and abandonment. Costs are ongoing and can exceed revenue.

A royalty interest is a right to a share of production revenue with no obligation for costs. The mineral owner typically retains one. Overriding royalties are carved out of the working interest.

Which one you hold determines both your economics and your exposure. A working interest can produce a cash call. A royalty cannot.

Note the distinction between gross and net revenue interest. A 25% working interest doesn’t mean 25% of revenue — it means 25% of the working interest’s share after royalties are paid off the top. Ask for the net revenue interest, not the working interest percentage.

The Tax Treatment

This is the genuine draw, and it’s real — but it’s specific.

• Intangible drilling costs (IDC). The non-salvageable portion of drilling expense — labor, fuel, site preparation, typically 60–80% of a well’s cost — can generally be deducted currently rather than capitalized. This concentrates a large deduction in year one.
• Tangible costs are capitalized and recovered through depreciation over time.
• Depletion. Ongoing production income is reduced by a depletion allowance. Small producers and royalty owners may qualify for percentage depletion, subject to limitations.
• The active income exception. This is the structural point most people miss. Under Section 469(c)(3), a working interest held in a form that does not limit your liability is not treated as a passive activity — meaning losses can generally offset active income rather than being trapped as passive losses.

That exception is the reason many oil and gas programs are structured as general partnerships rather than limited partnerships. The tax benefit is purchased with unlimited liability. That is a real trade, not a technicality, and it is often converted to limited liability after the drilling phase — which is why the conversion timing appears in the offering documents and deserves reading.

Two consequences that follow: working interest income is generally subject to self-employment tax, and you may have state filing obligations in the state of production even if you’ve never been there.

None of this is tax advice, and none of it works the same way for every investor. Alternative minimum tax, at-risk rules, and your own basis position all affect the outcome. Take this to your CPA before, not after.

The Diligence Checklist

• Operator track record on prior wells — including the ones that didn’t work
• Whether the sponsor takes a promoted interest, and at what level
• Decline curve assumptions and the commodity price they assume
• Plugging and abandonment liability, and who carries it
• Whether you are buying a working interest directly or a partnership interest in an entity that holds one
• Lease terms and expiration, including held-by-production provisions
• Insurance and environmental liability allocation
• Whether this is development drilling near existing production or exploratory

What This Is Not

It is not a bond. Cash distributions from a producing well are a function of commodity prices and decline rates, both of which move.

Conventional wells decline steeply in early production — a substantial share of total recoverable volume can come out in the first year or two, with a long low-rate tail after. A projected distribution schedule built on those early rates is a model, not a schedule.

And the end-of-life liability is real. Plugging and abandonment is a legal obligation that arrives when the well no longer produces revenue to pay for it. Find out in writing who carries it before you subscribe.