When energy prices rise, they become a nuisance for consumers, but is considered a boon for energy producers. In between are investors who want to cash in without the stomach churning uncertainty of major losses. One solution is following the lead of oil and gas royalty companies to invest in the industry.Since backyard drilling is not an option for most people, the alternative of buying energy stocks offers a better solution. Still, that does not represent a pure energy investment because there are other issues that can affect stock prices.
Investments in royalty trusts, which are similar to master limited partnerships, pass on oil and gas field income. These trusts are traded the same as stocks and offers investors a sizable income. These are also treated in a more favorable light when it comes to filing taxes.What is a Royalty Trust?In general, royalty trusts are high-yielding investments for individual investors. The very unique tax benefits also make these more appealing than other forms of investing in the industry. When an oil and gas producer issues units of a royalty trust for purchase on the open market, it can raise capital to go towards development projects in a particular field.Those who buy into the trusts are exempt from the normal corporate tax because the trusts are considered pass-through entities.
Although this is very similar to master limited partnerships (MLP), the difference is that royalty trust distributions are categorized as capital gains.Normally, you would pay income taxes on distributions from a MLP. Not so with the royalty trusts. These are taxed at a lower rate and you can depreciate the assets since you are effectively part owner in the company. This also lowers your costs so you can delay taxes, if necessary, and also receive certain tax credits.How Royalty Trusts Differ from BondsAnother difference to consider is royalty trusts versus bonds. Decline and commodity prices can determine payments on bonds, which comes with noticeable changes over time. You risk not getting all of the principal you paid for the bond. Characteristics of the oil field determines what you can get back.On a good day, royalty trust appear to be the best investments that you can make. Other days, they may look extremely terrifying to become part of your portfolio. This is due to their value being based on commodity prices.Do not let that discourage you, however. There are ways to find the best royalty trust where the performance matches your investment goals.