What is an American Income Trust?

An American Income Trust is a type of royalty trust.

How Does an American Income Trust Work?

A royalty trust is a type of corporation created to act as the owner of the mineral rights to wells, mines and similar properties. It exists only to pass income generated from the sale of the property's assets (gold, oil, etc.) to shareholders. No income tax is paid at the corporate level as long as the bulk of income (at least 90%) is passed-through to shareholders in the form of distributions or dividends.

American income trusts commonly focus on maintaining their existing assets rather than making capital expenditures (i.e. spending money to upgrade or maintain their assets). American income trusts generally distribute cash until their natural resource assets are depleted (this is why knowledge of a particular trust’s reserves is important). The high payout of American trusts may be attractive in the short-term, but the downside is that it leaves the trusts with very little cash for future growth.

The tax implications of investing in American income trusts are complicated. Distributions are taxed as regular income rather than at the lower 15% dividend tax rate, and investors may have to file tax returns in the states where the trust operates. Fortunately, investors don't pay taxes on a portion of these distributions until they sell their units. Unitholders are also entitled to certain deductions based on the depreciation of the trust's assets.

Contrary to other dividend paying securities, dividend yields from trusts usually stay high when the trust’s profit (and hence the unit price) rises. Likewise, when earnings fall, dividend yields from energy trusts usually suffer. This happens because when the price of the underlying assets is high, the trust makes more income, which it must then pay out. The reverse is also true: lower commodities prices mean lower profits, which mean lower distributions and a lower unit price.

Why Does an American Income Trust Matter?

Royalty trusts are a way to participate in the commodities markets without entering the futures market. Regardless, some income investors might find the tight commodities correlation and the distribution volatility too risky, even if that risk can be mitigated through diversification.

It is important to note that American income trusts differ from Canadian income trust trusts. Canadian trusts can raise money by issuing shares or borrowing money, and they often use this money to buy new reserves or develop existing properties. This ability to sustain and increase distributions indefinitely often makes Canadian trusts more attractive to investors. Canadian trusts also tend to be more tax efficient than American trusts because they reinvest their cash flow, making their dividends generally eligible for the lower 15% dividend tax rate. However, they are not usually listed on American exchanges (although some Canadian trusts are interlisted, meaning they trade both in Canada and in the U.S.). Canadian investments do offer a hedge against the falling U.S. dollar, but their foreign stocks also carry the political and economic risk of their home countries.