How to make oil and gas royalties show up as passive income?

[SuzB92]

I am working on a trust return (1041), and I entered oil and gas royalties from a 1099 on schedule E.  I chose property type 6 in box 1b and included the royalty income on line 4, yet Proseries Professional is showing it as nonpassive income and including it on line 5 of the K1 when it should be line 6.  Any ideas how to get Proseries to report it as passive income? 

[ljr]

Did you look to make sure you didn't check off a box on schedule E that says active participation?

[SuzB92]

The material participation and active participation checkboxes are all blank.

[Just-Lisa-Now-]

Wouldn't you want it on the K-1 Line 5 as Portfolio and Non Business income rather than Line 6 as Ordinary Business Income?

[sjrcpa]

What makes you think it should be passive?

[SuzB92]

I need it to be classified as passive income.  Proseries is forcing the royalty income to be non-passive on the K-1 worksheet (line 5) and Distributable Income worksheet [Part I, line 5e and Part II, column e (should be column f)] and I cannot figure out why.  I do very few trust returns so I'm probably missing something obvious.  The only income for the trust is oil and gas royalties.

[SuzB92]

There is no participation in the income generation.  The trust receives periodic checks from oil & gas companies for royalties.  

[sjrcpa · Accepted solution]

Look at IRC Section 469(e)(1)(A)(i)

[SuzB92]

Interesting thank you!

[sjrcpa]

You're welcome.

[capcpa1]

I am running into this same issue.  After reviewing the rules in the IRC section, it indicates:

"The term "passive activity" shall not include any working interest in any oil or gas property which the taxpayer holds directly or through an entity which does not limit the liability of the taxpayer with respect to such interest." 

So, if the ownership of the oil & gas interest is through an entity that limits the taxpayer's liability, they do not fall under this rule and the income is considered passive. Further research clarifies that "limited liability" for the purpose of this code section includes a taxpayer with ownership in the form of a limited partnership interest (i.e. is NOT a general partner). This is my taxpayer's situation, so I need to be able to mark this flow-through K-1 Royalty income on Schedule E, page 1, as passive.  However, the system is automatically marking it non-passive.  No material or active participation boxes are checked.  Is there a way to make this income passive on Schedule E, page 1?? This is for a trust (Form 1041), not sure if that makes a difference.

[msmith7305]

The rule you are quoting refers to a "Working Interest". The royalties you are receiving are, apparently, a Royalty Interest and not a "Working Interest". There is a big difference.