Please ensure Javascript is enabled for purposes of website accessibility

USO Investors: Get Ready for This Huge Hassle

By Dan Caplinger - May 2, 2020 at 9:01AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Many new shareholders in the oil-tracking fund don't know what they've gotten themselves into.

Oil prices have plunged, and bullish energy investors find themselves wanting to bet on an oil price recovery in the near future. Many of them have turned to United States Oil Fund (USO -1.48%), an exchange-traded investment that tries to track changes in the spot price of West Texas Intermediate crude oil.

U.S. Oil Fund has gotten a lot of attention recently because of the wild swings in its shares and the huge shifts in its strategy that it's had to make in order to deal with the unprecedented conditions in the oil markets. Yet as speculators pile into the shares, there's one thing that many of them aren't paying attention to -- and it could make their lives a lot more complicated than they realize.

How USO is different from most funds

Most people think of USO as an exchange-traded fund because its shares trade on the stock market during regular business hours. Yet technically, U.S. Oil Fund is set up as a limited partnership, and what investors are buying are actually limited partnership interests rather than shares of a corporation.

Four oil wells under an orange sky with the sun shining.

Image source: Getty Images.

Being a partnership rather than a corporation has a number of ramifications, most of which don't have a huge impact on investors. Yet the big difference for investors in U.S. Oil Fund is that shareholders have to deal with the tax complications of receiving a Schedule K-1 information return every year they're invested in the fund.

That might not seem like such a big deal, since USO doesn't typically pay out distributions. With the fund's sole goal of tracking the price of oil, it doesn't invest in income-producing securities, so there's no income for the fund to pay investors.

However, even though it doesn't actually pay out money to its investors, United States Oil Fund does have to report various tax items to its limited partners. The K-1 can therefore include allocations of income and expenses to each investor, representing the proportional share of the limited partnership's entire operations. Investors have to report that income on their tax returns, even though they didn't receive any actual cash.

What happens when you sell your USO?

Things get even more complicated when you decide to sell out your position in U.S. Oil Fund. As the fund's own information states, your tax reporting responsibility for selling shares requires you to report gains or losses on the sale.

In determining whether you have a gain or a loss, you have to adjust your tax basis to reflect some of the information that shows up on K-1 statements. As the fund literature further explains, you'll generally increase your tax basis by income and gain reported to you on a K-1, while reducing your basis for expenses.

Good news for retirement investors

Many investors in limited partnerships find out the hard way that using tax-favored retirement accounts to invest in them isn't the perfect solution it seems to be. Ordinarily, investors don't have to worry about tax consequences of their investments inside an IRA or other retirement account, because taxes only get charged when you make withdrawals from the account. However, in many cases, partnerships produce something called unrelated business taxable income (UBTI), and too much UBTI can have severe consequences for retirement accounts that can lead to having to pay taxes or even jeopardize the tax-exempt status of the retirement account.

That's an especially important issue for energy investors, because many companies in the sector are set up as master limited partnerships that have to observe those rules. For USO investors, though, UBTI isn't a problem right now. In its 2019 materials, the fund states that none of its allocated income is treated as UBTI. Therefore, owning USO in a retirement account could be a way to avoid some of this mess -- assuming current tax laws don't change in the future.

Know what you're getting into

The worst time to find out about all these tax complications is after you've already invested money in USO. Fortunately, the complications aren't all that dire and are mostly just a nuisance. Your accountant won't be happy with you, but it's not something you can't solve and fix.

Going forward, though, the lesson to learn is that it's important to do research on investments before you buy them. Knowing what to expect can help you steer clear of investments that will end up being more trouble than they're worth.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

United States Oil Fund LP Stock Quote
United States Oil Fund LP
$73.67 (-1.48%) $-1.11

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/06/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.