Course 503: Unconventional Equities
Drawbacks of Royalty Trusts
In this course
1 Introduction
2 Benefits of REITs
3 Drawbacks of REITs
4 Benefits of MLPs
5 Drawbacks of MLPs
6 Benefits of Royalty Trusts
7 Drawbacks of Royalty Trusts
8 The Bottom Line

The downsides to royalty trusts include the following:

Depletion, Depletion, Depletion. Royalty trusts own royalties on a finite amount of resources. Once those resources are gone, they're gone. As the resources deplete, royalties and distributions will fall and will, eventually, go to zero. In financial terms, there is no terminal value. Granted, most trusts won't hit this point for two or three decades (or more), but it's still incredibly important to consider that distributions will eventually contract and disappear.

Volatile Distributions. Trusts typically pay out their distributions on a quarterly or monthly basis. If royalties fall in that period due to the underlying commodity price tanking, distributions will also fall. It's entirely conceivable that a trust that yielded 15% in the last 12 months could yield 3% in the next 12.

Tax-Filing Complexity. Owners of royalty trusts are required to report the pro rata portion of a trust's total income and expenses on their tax returns. This typically means filing SchedulesE andB as well as having additional work with Form 1040.

State Income Taxes. Owners of trusts are liable for paying income taxes in the states in which the trust generates its royalties. Different states have different thresholds for when taxes have to actually be filed and paid, and the likelihood of owing income tax in multiple states increases with the size of a given ownership position.

Next: The Bottom Line >>

Print Lesson |Feedback | Digg! digg it
Learn how to invest like a pro with Morningstar’s Investment Workbooks (John Wiley & Sons, 2004, 2005), available at online bookstores.
Copyright 2015 Morningstar, Inc. All rights reserved. Please read our Privacy Policy.
If you have questions or comments please contact Morningstar.