7862 / What limits apply to the deductibility of a limited partner’s share of partnership losses in an oil and gas partnership?

(1) Partnership basis. A limited partner may deduct the limited partner’s share of partnership losses (including capital loss) only to the extent of the limited partner’s adjusted tax basis in the partnership interest (determined at the end of the tax year, but before reduction for partnership losses for the year). Any excess of such loss over basis is allowed as a deduction at the end of the partnership year in which such excess is repaid to the partnership.¹

Where a limited partner’s share of partnership losses exceeds that partner’s adjusted tax basis in the partnership interest, the amount of the limitation (i.e., the partner’s tax basis) must be allocated among several categories (e.g., long-term capital loss, short-term capital loss, IRC Section 1231 loss, etc.) according to the proportion that the loss in each category bears to the total loss. Furthermore, if there is taxable income rather than loss in any category (e.g., short-term gain), the limitation amount (i.e., the partner’s tax basis) will be increased by the amount of that income before the limitation is allocated among the categories in which there is a loss.²

Example. At the end of the tax year, limited partner C has the following distributive shares of partnership items: long-term capital loss, $4,000; short-term capital loss, $2,000; “bottom line” income, $4,000. Partner C’s adjusted tax basis in his partnership interest at the end of the year, but before adjustment for any of the foregoing items is $1,000. Adjusted as described in the text above, C’s tax basis is increased from $1,000 to $5,000 at the end of the year. C’s total distributive share of partnership loss is $6,000. Since without regard to losses, C has a tax basis of only $5,000, C is allowed only 5/6th ($5,000/$6,000) of each loss–$3,333 of his long-term capital loss and $1,667 of his short-term capital loss. C must carry forward $667 as long-term capital loss and $333 as short-term capital loss.³

(2) Amount at risk. A limited partner in an oil or natural gas program may deduct the limited partner’s share of partnership losses only to the extent the limited partner is “at risk” with respect to the interest in the partnership. For further explanation of this “at risk” limitation, see Q 7863, Q 7864, and Q 8004 to Q 8009.

(3) Passive loss rules. Application of the passive loss limitation to an investment in an oil or gas program depends on the form in which the investment is made and the material participation of the investor in the activity (see Q 7865).