Nonrecourse debt lets a lender collect only from the asset that secures the loan, not from you personally. For oil and gas investors, that feature rarely turns into a bigger deduction. The IRS at-risk rules generally exclude ordinary nonrecourse loans used to finance an oil and gas activity, so borrowed money you are not personally liable for usually does not widen the losses you can use. This guide explains why, how basis, at-risk amounts and passive-activity status differ, and what to ask a sponsor before you rely on any projected write-off.
TL;DR
- Nonrecourse means the lender can only seize the collateral. It does not mean the debt is invisible to the IRS, and it does not mean it creates a deduction.
- Under the at-risk rules, oil and gas exploration is a covered activity, and ordinary nonrecourse loans used to finance it generally are not amounts at risk.
- Three tests apply separately: partnership basis, the at-risk limit and passive-activity status. Passing one does not mean passing the others.
- How you hold the interest matters. A direct or unlimited-liability working interest is treated differently from an interest held through a liability-limiting entity.
- Ask for the debt documents, the operating agreement and a written tax analysis from your own CPA before you count on a deduction.
Table of Contents
- What nonrecourse debt means in an oil and gas deal
- Three separate tests: basis, at-risk and passive
- Why leveraged drilling structures draw IRS scrutiny
- Where the real first-year deduction comes from
- A practical checklist before you accept a leveraged deal
- Diligence beyond the tax math
- Our perspective on debt in energy investing
- Browse vetted energy projects
- FAQ
- Sources
What nonrecourse debt means in an oil and gas deal
A recourse debt makes the borrower personally liable. Everything else is nonrecourse: if the project fails, the lender’s remedy stops at the collateral, such as a lease, wells or production revenue.
In a partnership, the IRS practice unit on liability allocation says a liability is nonrecourse when no partner or related person bears the economic risk of loss. That is a tax definition, not a marketing label. A sponsor can call a loan nonrecourse in a pitch deck, yet the tax result depends on who actually stands behind it, including guarantees and related-party arrangements.
You will meet debt in three common places in energy deals:
- Project-level borrowing. The operator or partnership borrows against reserves to fund drilling or acquisition.
- Seller financing. The seller of a producing property takes a note secured by the property.
- Investor-level financing. A lender, or the sponsor, finances part of your own contribution.
The third is where tax authorities look hardest, and we come back to it below.
Three separate tests: basis, at-risk and passive
Most confusion comes from treating “my share of the debt” as one number that unlocks one deduction. It is at least three numbers, tested in sequence.
| Test | Question it answers | How nonrecourse debt behaves |
|---|---|---|
| Basis (partnership rules) | How much loss can the partnership pass to you at all? | A share of partnership liabilities can increase your outside basis. |
| At-risk limit (section 465) | Are you economically exposed for that amount? | Ordinary nonrecourse loans for oil and gas generally do not count as at risk. |
| Passive-activity rules (section 469) | Can the loss offset your wages or other non-passive income? | Depends on how you hold the interest and how much liability you carry. |
A loss has to clear all three. Debt can raise basis and still leave you with a loss you cannot use this year. That is why a careful advisor models each test separately before promising anything.
Basis and the partnership allocation rules
When a partnership borrows on a nonrecourse basis, the losses and deductions it generates cannot have economic effect, because the lender, not a partner, bears the burden if the asset falls short. Treasury Regulation section 1.704-2 handles this with its own rules for “nonrecourse deductions” and for minimum gain.
Two practical points follow:
- Allocations must follow the partners’ interests in the partnership, so the operating agreement has to say how nonrecourse deductions are shared.
- Minimum-gain chargebacks can later allocate income to you when the partnership’s minimum gain decreases, for example when debt is paid down or the property is sold or foreclosed. A deduction taken early can come back as income later.
The IRS practice unit describes a partner’s share of a nonrecourse liability as the sum of three components in order: section 704(b) minimum gain, section 704© minimum gain and excess nonrecourse liabilities. Your Schedule K-1 and the capital account records are where that math should show up. Do not assume your share of the debt automatically creates deductible basis.
The at-risk limit is where oil and gas differs from real estate
Real estate investors know the “qualified nonrecourse financing” exception: certain commercial loans secured by real property count as at risk even though nobody is personally liable. Oil and gas investors often assume the same logic applies. It does not.
The Form 6198 instructions (November 2025) list oil and gas exploration or exploitation among the activities subject to the at-risk rules. They also say ordinary nonrecourse loans used to finance the activity, acquire activity property or acquire your interest in it generally are not amounts at risk. The exception for financing secured by real property used in holding real property excludes mineral property.
In plain terms: if you invest $100,000 of your own cash and a partnership also borrows $300,000 without anyone being personally liable, your at-risk amount is generally closer to your $100,000 than to $400,000. The extra debt may still affect basis, but it does not by itself create a usable loss beyond what you stand to lose.
This is a simplified illustration, not a calculation for your return. Your own exposure can change if you guarantee the loan, pledge other assets or are personally liable in some other way, and each of those facts changes the analysis.
Passive-activity status turns on how you hold the interest
The third test is separate again. According to IRS Publication 925 for 2025, a working interest in an oil or gas well held directly, or through an entity that does not limit your liability (a general-partner interest is the example given), is generally not a passive activity, even if you do not materially participate. A limited-liability investment does not get that blanket exception. Qualifying nonpassive working interests are reported on your normal schedules rather than Form 8582, and special treatment can apply if your liability was limited for part of the year.
That creates a real tradeoff. Holding an interest in a way that does not limit your liability can open the door to non-passive treatment, but it also means you carry the legal exposure that comes with it. Holding through a liability-limiting entity protects you, and it generally gives up that automatic exception.
If you do use an LLC or similar vehicle, its protection depends on keeping it in good standing. Upkeep such as annual filings, registered agents and corporate records varies by state, and this overview of annual requirements to maintain limited liability shows the kind of routine a California entity faces. Ask your attorney what your own state requires.
For how passive losses carry forward and interact with the $25,000 allowance, see our piece on passive losses and the energy tax twist.
Why leveraged drilling structures draw IRS scrutiny
The IRS has a long record of looking at leveraged drilling partnerships. A Large Business and International directive, discussed by Tax Notes, addresses arrangements in which investors claimed losses and current deductions for intangible drilling and development costs in amounts exceeding what they had actually put in.
The underlying question under section 465 is whether you face a realistic possibility of economic loss. Courts have looked at whether a leveraged arrangement is built to remove that possibility. Nominal investor liability or very long-term notes can be tested for economic substance. The source notes that circuits have taken differing approaches and cites cases such as Levien, American Principals, Waters and Young.
The lesson is not that debt is bad. It is that a structure’s label does not decide the outcome. If a pitch leans on a large first-year write-off created mainly by financing you are not exposed to, that is the moment to slow down and get transaction-specific tax advice.
Where the real first-year deduction comes from
For most direct oil and gas investors, the headline deduction is not debt-driven. It comes from intangible drilling costs (IDCs), which cover things like wages, fuel, repairs, hauling and supplies that are necessary for drilling and preparing wells and have no salvage value. The IRS says section 263© lets a taxpayer elect to deduct these costs rather than capitalize them, and that each cost must be examined to see whether it really relates to drilling and development.
This is why cash invested in a well is the cleaner story. Your money pays for drilling costs, and the election determines when they are deducted. Whether you can use the deduction against wages still depends on the at-risk and passive-activity tests above, plus your own limits and alternative minimum tax position. You can see how the numbers might look for your bracket with our free oil and gas tax deduction calculator, then confirm them with your CPA. For the broader picture, read how oil and gas investments can lower your taxes.
A practical checklist before you accept a leveraged deal
Use these questions with any sponsor who mentions debt alongside tax benefits.
- Whose name is on the loan? Project-level, partnership-level or yours. Request the note and security agreement.
- Is anyone personally liable, including guarantors or related parties? This decides whether the debt is nonrecourse for tax purposes.
- Was any of the financing used to acquire your interest? The Form 6198 instructions single this out.
- What does the operating agreement say about allocating nonrecourse deductions and minimum-gain chargebacks?
- How is your interest held? Direct working interest, general-partner interest or limited-liability entity.
- What is the projected deduction, and which test does each dollar clear? Ask your CPA to show basis, at-risk and passive results separately.
- What happens if the debt is refinanced, paid down or foreclosed? Look for income recapture.
- Who is selling it to you, and how are they paid? See the next section.
Diligence beyond the tax math
A correct tax analysis on a bad project still loses money. The SEC’s investor alert on private oil and gas offerings warns that these offerings can carry a high degree of risk, including total loss and limited liquidity. It also stresses that working with a registered broker or adviser is not a seal of approval, and accredited status does not guarantee protection.
The SEC and the Texas State Securities Board point to the same habits:
- Verify who is soliciting you and check registration where it applies.
- Ask for the broker’s due-diligence report if a broker is involved.
- Look into the promoter’s history and conflicts of interest.
- Review commissions, fees, payment timing, transfer restrictions and liquidity.
- Independently check geological maps, production reports and state regulator filings, because exempt offerings may not carry state-registration protections.
In practice, the bottleneck is rarely finding a projected deduction. It is confirming that the project, sponsor, securities exemption, financing, reserves, production assumptions, fees and exit terms actually support the projection. These guides go deeper on each step:
- How to read an oil project prospectus
- How accredited investors vet private oil and gas deals
- The oil project underwriting process
- Escrow red flags in oil and gas investments
Our perspective on debt in energy investing
We see the same pattern with high-income professionals who come to energy investing for tax reasons. They arrive with a number in mind, usually a first-year deduction, and ask how much leverage can increase it. We think that is the wrong first question.
Our view is that the project should justify the deduction, not the other way around. Debt is a financing tool, and nonrecourse debt shifts risk to a lender, which is exactly why the tax rules do not let it multiply your loss for oil and gas the way many people expect. A structure that depends on that multiplication is leaning on the part of the tax code the IRS has historically examined most closely.
What we would rather you focus on is what you can verify: the operator’s track record, the project’s documents, how the interest is held, and the fees and exit terms. We built our platform around vetted operators and a clear presentation of key project materials so you can compare deals on those facts. Whatever you choose, have your CPA or tax attorney model basis, at-risk and passive treatment on the actual documents before you commit capital.
— Sharif
Browse vetted energy projects
If you are an accredited investor weighing direct energy exposure, Fieldvest lists producing assets, development projects and energy infrastructure from vetted U.S. operators. You can review project materials side by side and see what each deal is, and what it is not, before you decide. Explore the projects on Fieldvest or start with our oil and gas investing guide for accredited investors.
FAQ
Does nonrecourse debt increase my oil and gas tax deduction?
Usually not in the way people hope. A share of partnership debt can raise your partnership basis, but the at-risk rules generally exclude ordinary nonrecourse loans used to finance an oil and gas activity. Your usable loss is limited by the lowest result across the basis, at-risk and passive tests.
Is there a real estate-style exception for oil and gas?
No. The qualified nonrecourse financing exception covers financing secured by real property used in holding real property, and the IRS carves out mineral property from it. Oil and gas investors cannot count on the same treatment that commercial real estate investors may get.
Can an oil and gas working interest offset my W-2 income?
It can in some cases. Publication 925 says a working interest held directly, or through an entity that does not limit your liability, is generally not a passive activity. You still have to clear basis and at-risk limits, and holding the interest this way means accepting more legal exposure. Your CPA should confirm how it applies to you.
What documents should I request to check the debt?
Ask for the loan agreement, any guarantees, the security documents, the operating or partnership agreement and a sample Schedule K-1 if available. Then ask your tax advisor to reconcile them with the projected deductions. If a sponsor will not share them, treat that as a warning sign.
Sources
- Instructions for Form 6198 (Rev. November 2025), IRS
- Publication 925 (2025), IRS
- 2025 Publication 925 (PDF), IRS
- Determining Liability Allocations, IRS practice unit
- 26 CFR § 1.704-2, Legal Information Institute
- IRS Addresses Tax Consequences of Leveraged Oil and Gas Drilling Partnerships, Tax Notes
- IRS guidance on intangible drilling costs and section 263©
- Private Oil and Gas Offerings, SEC investor alert
- Investor Alert: Private Oil and Gas Offerings, Texas State Securities Board
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