W ant to turn high energy prices to your advantage? Consider investing in a natural gas drilling limited partnership fund. In addition to protecting against inflation, these funds provide big initial tax deductions -- as much as 85% or more of the invested amount -- and might provide partially tax-sheltered income from ongoing cash flows. They also diversify your portfolio -- energy prices and prices of stocks in general tend to move in opposite directions.
The minimum limited partnership investment can be as little as $10,000, but because tax advantages are needed to balance out the risks, these funds are most appropriate for people in high tax brackets. They’re typically used by investors with high income in a given year, perhaps due to a large bonus, sale of a business or exercise of stock options.
Caution: A portion of the write-offs from this investment may may be treated as a tax preference. Tax preferences are certain deductions that are not deductible for purposes of computing the alternative minimum tax. Consult your tax adviser.
BUYING INTO A PARTNERSHIP
It’s safest to invest in “developmental drilling” partnerships, which search for gas in regions where it’s already known to exist. About 90% of wells in developmental drilling partnerships produce at least some natural gas.Energy limited partnerships are sold through financial planners. Ask your financial professional to choose a reputable partnership sponsor that has been in the business for years.
If you decide to invest, act quickly. Many partnerships are in heavy demand starting in the second quarter of the year, when investors get a feel for the amount of a tax write-off they will need to offset income for that year. Each fund offers a limited number of shares.
DRAWBACKS
Energy partnerships should not make up more than 10% of a portfolio. In addition to the risk that a partnership might find little or no gas, you could lose principal if the price of gas falls.There is no active secondary market for partnership units, so you are stuck with them once you acquire them. (Some sponsors do allow limited partners to sell back units at big discounts.)
Expect to own your partnership for as long as the wells are producing gas. That is likely to be at least five years, and it could be more than 20 years. This information and performance history are in the partnership offering documents.
Bottom Line/Personal interviewed Jack Hollander, chairman of Investment Program Association, an organization representing both sponsors and brokerages in the alternative investment arena, New York City. www.ipa-dc.org. He is a tax attorney with 20 years of experience in limited partnerships.
