Market Beat: Master Limited Partnerships
Master Limited Partnerships or MLPs trade on exchanges just like common stocks, but have a different structure which makes them attractive, especially for income-oriented investors.
Diversification is very important within an investment portfolio to help manage the different types of risk that investors face. Most investors should have some exposure to real estate and natural resources in their asset allocation. If you use broad-based index funds you will have exposure to those asset classes within your equity index funds.
MLPs were started in the early 1980s and the laws are such that they are limited to real estate and natural resources like oil and gas exploration and production. In an MLP there are two types of partners, the limited partners who are the investors that buy the shares on an exchange and the general partners who are responsible for the day to day management of the company.
There are several tax advantages to investing in MLPs. MLPs must earn a minimum of 90% of their income from real estate or natural resources. The income is passed through to the limited partners and is not taxed at the corporate level. Further, the income that the limited partners receive as cash distributions is considered to be a return of capital and not dividend income like with a common stock. If the partnership units are sold, the gain is treated as a capital gain. Investors can also get deductions for depreciation and depletion. There are many MLPs that pay out a relatively high yield.
For tax purposes K-1 forms are issued and they can be fairly complex to understand. They also have a later deadline than other tax forms like W-2s so owning MLPs can delay your tax filing. If you use an MLP inside a qualified retirement account like an IRA or self -directed 401k, they can generate unrelated business income within the tax deferred retirement account. A net loss from an MLP investment cannot be used to offset other gains, the losses must be carried forward to the next year.
The performance of MLPs overall has been pretty good. The S&P MLP Index is up over 12% year to date as of June 17th. The Alerian MLP Index has posted a gain of about 11% over the same time frame. Income oriented investors should consider using MLPs as a way to produce some cash flow on a tax favored basis.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.