When people think of the “alternative” investment types they can purchase with a self-directed IRA, they generally think of precious metals, real estate, private equity and private debt. (And let’s be clear, it’s probably unfair to think of these as “alternative” investments because they are fully authorized by the IRS regulations relating to IRAs.) Another asset class, and one that perhaps comes to mind as often, relates to the oil and gas industries.
Because oil and gas investments are less common, let’s discuss some of the basics for making those investments with a self-directed IRA.
Don’t Ignore the Learning Curve. Oil and gas investments are arguably one of the most complicated types of investment that you can make. Concepts of mineral interests, surface rights, working interests and royalty streams are not generally encountered with other investments.
Because many oil and gas investments are relatively illiquid, it’s absolutely essential that you do your due diligence on any potential investment, and fully understand the nature of the arrangement you may be participating in. As with any other investment, don’t rush into an oil and gas opportunity if you don’t fully understand all the relevant terms, provisions and risks.
Types of Oil and Gas Investments. There are a number of different ways to make investments in the oil and gas industries, including not only the commodities and futures contracts, but interests in the refining and drilling companies, as well as investing in land or mineral interests where drilling is taking place (or likely to take place in the future).
Other Energy Projects. Even though we’re focusing here on oil and gas investments, understand that other energy industry projects may provide you with similar opportunities. If you don’t find any suitable oil or gas projects to invest in, consider solar energy projects, wind energy, biofuel, or water energy projects as well.
The developments of just the past few years solidly demonstrate just how much potential there is for oil and gas activity within the United States. But you may also wish to consider other projects that may exist outside the United States.
Tax Considerations. Depending on the type of investment you’re considering, you should check whether there are tax incentives available for investments made with non-taxable funds. If so, and you have enough funds available in your taxable investment account, then you may wish to make the investment outside of your self-directed IRA in order to maximize your benefits. However, many of these tax breaks have expired as domestic development has boomed, so most potential investments may still be suitable for your self-directed IRA.
Also consult with an expert to understand how UBTI (Unrelated Business Taxable Income) might impact your investment. This concept (which can be an issue for self-directed IRA owners when they seek to use debt financing to make an investment – such as getting a mortgage for a real estate purchase) can result in an immediate tax bill for certain types of investments.
The key in all aspects of an oil or gas investment within your self-directed IRA is to do your homework.