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If you’re a high-income earner or experienced investor, you’ve probably run into the frustrating reality of the IRS’s passive activity loss (PAL) rules. Under these restrictions, losses from most passive investments—like real estate partnerships or private equity funds—can’t be used to offset active income (such as W-2 wages or business income).
But energy investing is different.
Thanks to a specific carveout in the tax code, non-operated working interests in oil and gas may allow you to bypass these limitations—turning what would typically be “trapped” losses into active, usable tax offsets.
Let’s unpack how this works, and why it’s one of the most powerful—and underutilized—tax advantages in alternative investing.
The IRS defines a passive activity as any trade or business in which you don’t materially participate. Most partnerships, real estate investments, and limited partnerships fall into this category.
Under Section 469 of the Internal Revenue Code:
This often leads to a situation where investors are earning millions in W-2 or business income, but can’t fully deduct losses from alternative investments—even if those losses are real and material.
Here’s where energy investing flips the script.
If you invest in a working interest in an oil or gas property—and that interest is not held through an entity that limits liability (like a limited partnership or LLC)—then the IRS does not classify that income or loss as passive.
This means losses generated from your investment can be used to offset your active income—including wages, business income, and portfolio income.
This is an exception not available in real estate or most other private alternatives. And for the right investor, it can materially reduce tax liability in the same year the investment is made.
To benefit from this exception, your investment must meet the following criteria:
Most individual investors meet these criteria when participating in properly structured direct investments—especially through firms like Basin Ventures that tailor deals for accredited investors with these tax advantages in mind.
Imagine you’re a tech executive earning $700,000/year in W-2 income. You invest $300,000 in a drilling program with Basin Ventures.
If the project is successful and generates cash flow in year two and beyond, that income will also benefit from ongoing depletion deductions and, potentially, capital gains treatment on exit.
Even if you don’t need to offset W-2 income, this structure gives you more tax flexibility than typical real estate or private equity investments. It allows for:
And unlike real estate—where loss deductibility often depends on proving “material participation” or meeting real estate professional thresholds—oil and gas investments offer a cleaner, more accessible path to usable tax benefits.
There are other potential ways to bypass passive loss limitations, though they are more complex:
These are advanced strategies—and should be reviewed with a CPA—but they show how versatile energy investing can be when tax optimization is part of the plan.
Of course, the ability to deduct a loss doesn’t eliminate investment risk. You’re still exposed to commodity prices, operator performance, and project-specific challenges.
Additionally:
But when structured correctly, oil and gas investments can turn IRS limitations into investor advantages—while contributing to real energy production.
Most private investments come with limitations. Losses get trapped. Income is taxed harshly. The IRS keeps more than its fair share.
But oil and gas investing is built differently.
The ability to deduct non-passive losses, especially in high-income years, makes working interest participation one of the most strategic tools for tax planning available to accredited investors today.
At Basin Ventures, we structure each project with this in mind—combining smart tax design with real operational discipline. Because we believe every dollar you invest should work harder than the ones you send to the IRS.
If you’re a high-income earner or experienced investor, you’ve probably run into the frustrating reality of the IRS’s passive activity loss (PAL) rules. Under these restrictions, losses from most passive investments—like real estate partnerships or private equity funds—can’t be used to offset active income (such as W-2 wages or business income).
But energy investing is different.
Thanks to a specific carveout in the tax code, non-operated working interests in oil and gas may allow you to bypass these limitations—turning what would typically be “trapped” losses into active, usable tax offsets.
Let’s unpack how this works, and why it’s one of the most powerful—and underutilized—tax advantages in alternative investing.
The IRS defines a passive activity as any trade or business in which you don’t materially participate. Most partnerships, real estate investments, and limited partnerships fall into this category.
Under Section 469 of the Internal Revenue Code:
This often leads to a situation where investors are earning millions in W-2 or business income, but can’t fully deduct losses from alternative investments—even if those losses are real and material.
Here’s where energy investing flips the script.
If you invest in a working interest in an oil or gas property—and that interest is not held through an entity that limits liability (like a limited partnership or LLC)—then the IRS does not classify that income or loss as passive.
This means losses generated from your investment can be used to offset your active income—including wages, business income, and portfolio income.
This is an exception not available in real estate or most other private alternatives. And for the right investor, it can materially reduce tax liability in the same year the investment is made.
To benefit from this exception, your investment must meet the following criteria:
Most individual investors meet these criteria when participating in properly structured direct investments—especially through firms like Basin Ventures that tailor deals for accredited investors with these tax advantages in mind.
Imagine you’re a tech executive earning $700,000/year in W-2 income. You invest $300,000 in a drilling program with Basin Ventures.
If the project is successful and generates cash flow in year two and beyond, that income will also benefit from ongoing depletion deductions and, potentially, capital gains treatment on exit.
Even if you don’t need to offset W-2 income, this structure gives you more tax flexibility than typical real estate or private equity investments. It allows for:
And unlike real estate—where loss deductibility often depends on proving “material participation” or meeting real estate professional thresholds—oil and gas investments offer a cleaner, more accessible path to usable tax benefits.
There are other potential ways to bypass passive loss limitations, though they are more complex:
These are advanced strategies—and should be reviewed with a CPA—but they show how versatile energy investing can be when tax optimization is part of the plan.
Of course, the ability to deduct a loss doesn’t eliminate investment risk. You’re still exposed to commodity prices, operator performance, and project-specific challenges.
Additionally:
But when structured correctly, oil and gas investments can turn IRS limitations into investor advantages—while contributing to real energy production.
Most private investments come with limitations. Losses get trapped. Income is taxed harshly. The IRS keeps more than its fair share.
But oil and gas investing is built differently.
The ability to deduct non-passive losses, especially in high-income years, makes working interest participation one of the most strategic tools for tax planning available to accredited investors today.
At Basin Ventures, we structure each project with this in mind—combining smart tax design with real operational discipline. Because we believe every dollar you invest should work harder than the ones you send to the IRS.
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