Royalty Trusts


Royalty Trusts typically own oil or natural gas wells, the mineral rights of wells, or mineral rights on other types of properties. An outside company must perform the actual operation of the oil or gas field, or mine, and the trust itself, in the United States, may have no employees. Royalty trusts, like MLPs, generally invest in energy sector assets. Unlike the steady cash flows at MLPs, royalty trusts generate income from the production of natural resources such as coal, oil, and natural gas. These cash flows are subject to swings in commodity prices and production levels, which can cause them to be very inconsistent from year to year. Royalty Trusts have no physical operations of their own and have no management or employees. Rather, they are merely financing vehicles that are run by banks, and they trade like stocks. Other companies mine the resources and pay royalties on those resources to the trust.

Royalty Trusts attract investors because of the relatively high, cash flow yields. Royalty Trusts in the United States and Canada usually involve oil and gas fields or mines which are at or past their production peak, and will gradually decline in output as well as revenue; however, the infrastructure to develop them has already been built, so that an investor can expect a reasonably steady income stream.

Royalty Trusts own numerous individual wells, oil fields, or mines, they represent a convenient way for the average investor to diversify investments across a number of properties. Also, since commodities are considered a hedge against inflation, the popularity of royalty trusts as investments rises as interest rates rise, and their shares often rise as a result. Royalty trusts allow investors to speculate directly on commodities such as gas, oil, or iron ore without having to buy futures contracts, or use the other investment vehicles traditionally associated with commodities—since the trusts trade like stocks.

Due to depreciation and depletion, distributions from most trusts are not considered income in the eyes of the IRS. Rather, these nontaxable income distributions are used to reduce an owner’s cost basis in the stock, which is then taxed at the lower capital gains rate and is deferred until an investor sells.

It is important to determine what percentage of your investment portfolio should be invested in Royalty Trusts based on your investment objectives, risk tolerances and investment time horizon.

Investors are advised to seek competent financial, tax and legal advice concerning the decisions they make with their investments. Klayman & Toskes, P.A. can provide you with a free consultation concerning any securities industry violations related to the handling of your investments accounts by a full-service brokerage firm or registered investment advisor.

Information contained on this webpage is for educational purposes only
and should not be considered legal advice.
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