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

To report oil and gas depletion from a K-1, pull the figures the partnership gives you in Box 20 under Code T, run two separate calculations — cost depletion and percentage depletion — apply the statutory limits, and deduct the larger of the two on Schedule E against the partnership activity, with a statement attached that shows your math. The partnership supplies the raw data; the calculation and the deduction are yours.

Where the Numbers Live on Your K-1

Schedule K-1 (Form 1065) carries depletion data in Box 20, Code T, labeled “Depletion information — oil and gas.” That entry reports your share of gross income from the property, your share of production for the year, and other data needed to figure depletion.¹ The partnership should also allocate your share of the adjusted basis of each oil or gas property.

Most of what you actually need sits on a supplemental statement attached to the K-1, not inside 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 anything, call the partnership’s tax department before you file. You cannot compute depletion without those figures, and estimating them is not an option.

Calculating Cost Depletion

Cost depletion recovers your remaining capital investment in the mineral property as the reserves come out of the ground. Three inputs drive it:

Adjusted basis: your capital investment in the property, reduced by all prior years’ depletion deductions.
Total recoverable units: the estimated 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 operations or development change the picture.²
Units sold: your share of production actually sold (not merely produced) during the year.

Divide adjusted basis by total recoverable units to get a per-unit rate, then multiply by units sold. An adjusted basis of $50,000, total recoverable units of 25,000 barrels, and your share of sales of 2,000 barrels produces cost depletion of $4,000. Once adjusted basis hits zero, cost depletion on that property stops. There is nothing left to recover.

Calculating Percentage Depletion

Percentage depletion ignores your cost. You deduct 15% of your gross income from the property.³ Unlike cost depletion, it can continue after you have fully recovered what you paid, so lifetime deductions can exceed your original investment. Take the gross income from the Box 20 Code T statement and multiply by 15% for a preliminary number. Three limits can cut it down.

The 100% Net Income Limit on Each Property

Percentage depletion on any single oil or gas property cannot exceed 100% of the taxable income from that property, figured before the depletion deduction itself. Other minerals face a stricter 50% cap; oil and gas get 100%.⁴ A property with $30,000 of gross income and $28,000 of operating expenses leaves $2,000 of net income, and percentage depletion for that property is capped at $2,000 regardless of what 15% of gross would have given you.

The 1,000-Barrel-Per-Day Production Limit

Percentage depletion for independent producers and royalty owners is limited to 1,000 barrels of oil equivalent per day of average production, with natural gas converted at 6,000 cubic feet per barrel.³ This ceiling applies across all your partnership interests combined. A single K-1 investor rarely bumps into it. Accumulate positions across several producing partnerships and it becomes worth checking.

The 65% Taxable Income Limit

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

If the 65% cap reduces your deduction, the disallowed amount is not lost. It carries forward and is treated as percentage depletion allowable in the next year, subject to the same 65% test.⁵ When the carryforward is eventually used, the basis of the property that generated it is adjusted downward at that time. If you dispose of the property before using the carryforward, it is reduced by the difference between your actual adjusted basis at sale and what the basis would have been without the 65% limitation.

Who Cannot Use Percentage Depletion

Percentage depletion on oil and gas is reserved for independent producers and royalty owners. Two groups are shut out. Retailers lose access if the taxpayer or a related person sells oil, gas, or derived products through retail outlets, unless combined gross receipts from such retail sales stay below $5 million for the year.³ Large refiners lose access if the taxpayer or a related person operates refineries with average daily runs exceeding 75,000 barrels. Typical K-1 investors who do not also run gas stations or refineries are unaffected, but the related-person rules sweep broadly, so if your family or affiliated entities have operations in the supply chain, check carefully.

Choosing the Larger Deduction

After running both methods, you claim the larger. Section 613 states that the depletion allowance under Section 611 cannot be less than it would be if computed without reference to the percentage method, which makes cost depletion a floor.⁴ Both calculations are required every year, even when one has been the winner historically. Reserve estimates get revised, commodity prices move, and the better method on a given property can flip from year to year.

Compare property by property, not in aggregate. Percentage depletion may be larger on one well while cost depletion wins on another, and nothing stops you from using different methods on different properties. The 65% taxable income cap is the only limitation that works across your whole portfolio; the rest apply at the property level.

Putting the Deduction on Your Return

The final depletion number goes on Schedule E (Form 1040), which handles partnership, S corporation, and royalty income and loss.⁶ Enter the deduction in the column tied to your partnership activity, where it reduces the K-1 income reported for that partnership. The net result on Schedule E flows to Schedule 1 and then to Form 1040.

Attach a statement showing how the deduction was computed. For cost depletion, show adjusted basis, units sold, total estimated recoverable units, and the resulting figure for each property. For percentage depletion, show gross income, the 15% calculation, and how each limitation was applied. Property-by-property records are what will protect the deduction if the return is examined years later.

Two Gates Before the Deduction Counts

Depletion still has to clear the passive activity rules and the at-risk rules before it reduces your tax.

Passive Activity

Oil and gas activities generally produce passive income or loss for limited partners and royalty owners, meaning losses only offset other passive income. A working interest in oil or gas held directly or through an entity that does not limit the holder’s liability is not treated as a passive activity.⁷ Hold a working interest through a general partnership and the resulting losses, depletion included, can offset wages and investment income. Hold the same interest through a limited partnership or LLC and the exception does not apply.

At-Risk

Oil and gas exploration and development is specifically covered by the at-risk rules under Section 465.⁸ Deductible losses, depletion included, cannot exceed the amount you have at risk — the cash you invested plus borrowings for which you are personally liable or have pledged non-activity property. Nonrecourse debt, guarantees, and stop-loss arrangements do not count. Each property is a separate activity for this purpose, so the limit is tracked well by well.

How Depletion Moves Your Partnership Basis

Depletion also reduces 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 offset for the excess of percentage depletion over the adjusted basis of the depletable property.⁹ The net effect in most years is still a reduction.

Outside basis matters because it caps the losses you can deduct from the partnership. If cumulative depletion and other deductions have driven your basis near zero, additional losses are suspended until contributions or allocated income restore basis. A running basis schedule, maintained year after year, is what keeps this from becoming a crisis the first time the partnership generates a big loss.

Recapture When You Sell

Depletion does not vanish when you sell. Under Section 1254, gain on the sale of oil and gas property is treated as ordinary income to the extent of prior depletion deductions that reduced the property’s basis.¹⁰ The recapture amount is the lesser of total Section 1254 costs (which include basis-reducing depletion deductions plus intangible drilling cost deductions) or the gain on sale, and it applies even in some situations where gain would otherwise go unrecognized.

If you have claimed percentage depletion for years and cumulative deductions well exceed what you originally paid, the tax at sale can be large, and it comes at ordinary rates rather than capital gains rates. Keep lifetime depletion records for every property so the recapture figure is defensible when the interest is eventually sold.

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
Internal Revenue Service. About Schedule E Form 1040 Supplemental Income and Loss
7
Office of the Law Revision Counsel. 26 USC 469 Passive Activity Losses and Credits Limited
8
Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk
9
Internal Revenue Service. Partners Outside Basis
10
eCFR. 26 CFR 1.1254-1 – Treatment of Gain From Disposition of Natural Resource Recapture Property