Discover the Benefits of Master Limited Partnerships (MLPs)
A master limited partnership (MLP) is a business venture that blends the benefits of a private partnership with a publicly traded company. MLPs trade on national exchanges and generally boast cash flow stability, owing to a partnership agreement that mandates the distribution of a specific amount of cash to investors. This structure is particularly beneficial in capital-intensive industries like the energy sector.
The first MLP surfaced in 1981, and by 1987, Congress limited their use primarily to the real estate and natural resources sectors due to concerns over reduced corporate tax revenue. MLPs do not pay federal income taxes, making them uniquely advantageous.
Key Highlights
- Hybrid Structure: Combines the tax advantages of a private partnership with the liquidity of publicly traded stocks.
- Types of Partners: There are two types—general partners manage the MLP while limited partners are investors.
- Tax-Sheltered Distributions: Investors benefit from tax-advantaged income.
- Low-Risk, Long-Term Investment: Typically seen as offering slow but stable returns.
The Unique Charm of MLPs
A master limited partnership is a hybrid entity, combining features of partnerships and corporations. As such, MLPs issue units instead of shares, traded on national stock exchanges, making them liquid securities. Partners are often called unitholders rather than shareholders, each holding a portion of the MLP’s income, deductions, losses, and credits.
Partner Types
- Limited Partners: Investors who provide the capital and receive quarterly distributions.
- General Partners: Managers responsible for daily operations, holding a majority interest and possibly increasing their ownership.
Tax Benefits Galore
Pass-Through Taxation
MLPs enjoy pass-through tax treatment, meaning profits and losses flow directly to the limited partners who only pay taxes on their share of the income. This structure also passes deductions to partners, which diminishes their tax liabilities. To maintain this status, 90% of an MLP’s income must be from qualifying sources, primarily related to natural resources or real estate.
Deferred Taxes and Capital Gains
Quarterly distributions from MLPs are often treated as a return of capital (ROC), which are tax-deferred until units are sold. At that point, the capital gains tax and ordinary income tax rates apply, providing significant tax relief.
Weighing the Pros and Cons
Advantages
- Steady Returns: MLPs often deliver slow, consistent income, particularly in stable, slow-growth industries like pipeline construction.
- Tax Deferral: Large portions of distributions are often tax-deferred, and the flow-through structure avoids double taxation.
- Limited Liability: Liability for debts is limited to the partner’s investment.
- Estate Planning: Unitholders and beneficiaries avoid immediate taxes when MLP units are transferred or inherited.
Disadvantages
- Complex Taxes: Filing is complex and often requires detailed IRS forms (like Schedule K-1).
- State Taxes: Investors may have to file state income taxes in multiple states.
- Limited Use of Losses: Cannot offset other income with net losses until the units are sold.
- Modest Growth: Possesses limited upside potential in terms of asset appreciation.
Real-World Examples of MLPs
Most MLPs operate in the energy sector, managing resources for other energy businesses. Typical MLP activities include pipeline transportation, refinery services, and logistics for the oil industry. Brookfield Asset Management is a notable example with MLPs across real estate, infrastructure, and renewable energy sectors.
A Distinctive Investment Opportunity
Master limited partnerships represent an intriguing investment vehicle combining tax efficiency with liquidity. With professional general partners running operations, MLPs are commonly regarded as low-risk, long-term ventures, offering both stable income streams and advantageous tax structures.
Frequently Asked Questions (FAQs)
1. Does a Master Limited Partnership (MLP) Offer Tax Advantages?
Yes. MLPs offer a pass-through tax structure, and distributions are tax-deferred until units are sold.
2. What Are Some Examples of Master Limited Partnerships?
MLPs usually operate in natural resources or real estate sectors, such as oil and gas pipelines, crude oil production, and natural gas processing.
The Final Word
Master limited partnerships embody the advantageous combination of private partnerships’ tax benefits with the liquidity of publicly traded companies. They are particularly appealing for investors seeking a stability-grounded, long-term, and tax-efficient consideration.
Related Terms: Limited Partnership, General Partner, Passive Income, Income Tax, Return on Investment.
References
- U.S. Securities and Exchange Commission. “Updated Investor Bulletin: Master Limited Partnerships – An Introduction”.
- Congressional Research Service. “Master Limited Partnerships: A Policy Option for the Renewable Energy Industry”, Pages 5-6.
- Congressional Research Service. “Master Limited Partnerships: A Policy Option for the Renewable Energy Industry”, Page 5.
- Congressional Research Service. “Master Limited Partnerships: A Policy Option for the Renewable Energy Industry”, Pages 2-3.
- Internal Revenue Service. “Tax Information For Partnerships”.
- Congressional Research Service. “Master Limited Partnerships: A Policy Option for the Renewable Energy Industry”, Pages 1-2, 4.
- Congressional Research Service. “Master Limited Partnerships: A Policy Option for the Renewable Energy Industry”, Pages 2, 6.
- Intelligent Income. “MLP Tax Guide”.
- Congressional Research Service. “Master Limited Partnerships: A Policy Option for the Renewable Energy Industry”, Page 4.
- Internal Revenue Service. “Tax Cuts and Jobs Act, Provision 11011 Section 199a - Qualified Business Income Deduction FAQs.”
- Internal Revenue Service. “Publication 551, Basis of Assets”, Pages 9-10.
- Internal Revenue Service. “Publication 541, Partnerships”, Page 10.
- Internal Revenue Service. “Net Operating Losses”.
- Internal Revenue Service. “Publication 541, Partnerships”, Page 5.
- LINN Energy. “IRS Form 8937, Report of Organizational Actions Affecting Basis of Security”.
- LINN Energy. “LINN Energy 2015 Fact Sheet”, Page 1.
- LINN Energy. “About LINN Energy”.
- U.S. Energy Information Administration. “Electricity Data Browser”, Select Average Retail Price of Electricity.
- VettaFi. “Alerian MLP Index”, Download Factsheet, Page 1.
- U.S. Energy Information Administration. “Real Petroleum Prices: Short-Term Energy Outlook”.
- VettaFi. “Alerian MLP Index”.
- Brookfield Asset Management. “Home”.
