What is an MLP? MLP in the investment world means Master Limited Partnership. MLPs have generated some of the best returns for the past decade, and yet it’s a secret to most investors. I found out about them only three years ago.
They are publicly traded, and you can purchase one of many of the security exchanges. MLPs combine the tax benefits of a limited partnership, with the liquidity of a publicly traded security. It is known to some as a granny investment; they generate steady income, can appreciate like a stock, and have good tax benefits. I happen to love them since they are very similar, in tax advantages, to owning your own business.
Master Limited Partnerships are limited by US tax code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum, natural gas extraction and transportation. Some real estate enterprises may also qualify as MLPs.
In addition, some private equity management companies such as the recently gone public, Blackstone Group (BX) and Fortress Investment Group (FIG) are structured as MLPs. Many MLPs generate 7 – 8% dividend yields and most are tax-deferred. For many large master limited partnerships, 70% or more of their dividends are tax-deferred.
Advantages of an MLP?
- MLP distributions are high and consistent. Average yield is in the 8% range.
- MLPs have consistently increased their distributions over time.
- MLPs have a low correlation to bonds and stocks, which makes it perfect in your asset allocation mix.
- The corporate structure makes it a favorable tax treatment, and avoids double taxation.
MLPs have a big tax advantage compared to stocks with dividends and other assets classes. It’s a perfect investment to put into taxable accounts. While you can put an MLP in an IRA or other retirement account, it is not recommended because of the tax complexities.
With MLPs, you should practice a buy and hold mentality because of the tax implications. When selling a long-held MLP, the cost basis can be high because of the many years of dividends (they are really distributions).
With an MLP you do not get a standard 1099 form and get a K-1 tax form instead. Unlike dividends, these distributions are not taxed when they are received; instead, they are considered reductions in the investment’s cost basis and create a tax liability that is deferred until the MLP is sold. Because of this deferral, unit holders often pay an effective tax rate of under 10% of annual distributions. Depending upon your tax situation, this rate can fall as low as zero in some cases.
Here is a partial list of MLP stocks.
- Boardwalk Pipline (BWP)
- Enbridge Engergy (EEP)
- Enterprise Product Partners LP (EPD)
- Kinder Morgan Energy (KMP)
- Magellan Midstream (MMP)
- Plains All American (PAA)
For anyone who’s looking for a a steady income and nice tax deferral, an MLP might be something you want to add to your taxable portfolio.
Disclosure: I own shares of PAA and MMP.