Academic journal article Journal of Accountancy

Tax Benefits of Royalty Trusts: Another Way of Investing in Commodities

Academic journal article Journal of Accountancy

Tax Benefits of Royalty Trusts: Another Way of Investing in Commodities

Article excerpt

Royalty trusts provide income-oriented taxpayers with opportunities to invest in natural resources, realize cash flows and participate in the tax benefits afforded this specialized industry. To educate interested clients, CPAs should familiarize themselves with this type of investment.

WHAT ARE THEY?

Corporations owning natural resources create royalty trusts to raise capital, generate tax benefits or avoid tax burdens (for example, the alternative minimum tax). A royalty trust is a legal entity that purchases profit interests (interests that pass through profits, but not losses) in mature, low-risk, natural resource working properties (such as oil and gas). It sells beneficial interests (trust units) to investors to raise capital and distributes royalty income to unit holders, net of management fees.

WHY INVEST?

Royalty trusts promise high yields when compared with traditional equity investments and typically return no less than good quality bonds do. While their prices fluctuate, they currently provide about a 9% return (on an annualized basis).

In addition to providing unit holders with income from the working property, the trust passes through proportionate shares of any depreciation or depletion deductions or tax credits to which the underlying property is entitled. Trust units are publicly traded and readily marketable, and generally trigger capital gain or loss on a subsequent sale (although depletion deductions may have to be recaptured at ordinary income rates). The trust itself is not taxed.

For the risk-averse investor, royalty trusts offer diversification and a pure investment in commodities; they reduce a portfolio's overall risk and provide a hedge against inflation. …

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