For advisors and clients, this isn't their grandfather's energy sector. It's not even their father's.
The traditional energy sector now represents just 2.64% of the S&P 500, making it the second-smallest sector weight in the benchmark domestic equity gauge. Today, there are now energy stocks among the top 10 S&P 500 components – a far cry from a time in the 1980s when the sector accounted for almost a third of the index.
Those factoids don't mean clients should be out of energy altogether. Not when the S&P 500 Energy Index and the Alerian MLP Infrastructure Index both up more than 25% year-to-date, confirming signs of some form of energy renaissance. Of course, many clients are acquainted with the risks of investing in traditional oil and gas equities and while there was a time master limited partnerships (MLPs) didn't gyrate on par with crude prices, that hasn't been the case for some time.
Good news: Advisors can present clients with an avenue for damping some of that risk and it comes with income and tax advantages. Enter MDS Energy, a family owned, Pennsylvania-based natural gas driller. Through a partnership with Snyder Bros., MDS Energy has access to one of the largest remaining private acreage positions in the gas-rich Marcellus Shale.
MDS: An Avenue to Tax Breaks Galore
Because so many clients are wired to think of energy investing as integrated oil and exploration and production equities along with MLPs for income, many don't know about the myriad tax benefits that come along with direct energy investing, which MDS offers. In fact, IRS code is littered with goodies – believe it or not – pertaining to direct energy investing. Those breaks include intangible and tangible drilling costs.
“Intangible drilling costs include everything but the actual drilling equipment. Labor, chemicals, mud, grease, and other miscellaneous items necessary for drilling are considered intangible. These expenses generally constitute 60-80% of the total cost of drilling a well and are 100% deductible in the year incurred,” according to Investopedia.
Intangible costs are also exempted on the alternative minimum tax (AMT) return. Say it costs $500,000 to drill a well and it's determined that 75% of that sum is intangible costs, the investor would be entitled to tax deduction of $375,000. For high net worth clients, that's an attractive proposition amid a shifting U.S. tax landscape. Advisors are taking note.
“As automation and standardization continue to drive the financial services industry towards commoditization, Advisors are looking for ways to stand out. Tax mitigation strategy represents a great opportunity to add value and differentiate yourself from the competition. Performance may not vary all that much from one advisor to the next these days, but a significant reduction in tax liability can lead to meaningful outperformance, short and long term,” says Douglas Blake, managing director – investment services at Kingswood U.S.
Then there are tangible cost tax benefits. In the example above, there would be $125,000 in tangible costs, which can be written off via a seven-year depreciation schedule.
The MDS platform offers advisors exposure to other tax benefits, including depletion allowance and lease costs.
Direct energy investing isn't the most familiar concept, even for seasoned investment professionals. As such, advisors should prioritize the driller's track record and MDS has that in spades.
“MDS Energy Development jointly ventures with the Snyder Family on its investment partnerships. The company has successfully sponsored 15 tax-advantaged natural gas drilling partnerships, which have raised nearly $300 million dollars of outside investor capital,” according to the company.
Bottom line: High net worth clients love unique investment strategies and tax breaks. Advisors can deliver the best of both worlds by offering exposure to MDS Energy.
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