Confusion and misunderstanding can provide opportunities for people who are willing to make the effort to dig in to the detail and learn the fundamentals of difficult topics. Such as a befuddled 7th grader whose eyes glaze over once the math teacher first broaches the main topic of algebra, many investors shy from Master Limited Partnerships because they cannot fit typical for stock investments, have yields which can be “excessive,” aren’t measured by the exact same metrics as other equities, may not be befitting IRAs, and generally are “more difficult” to know than their other investments. However, for those ready to take the time to review slightly, they will realize that the entire world of MLPs is not totally all that complicated and can offer a wonderful opportunity for a long term steady and growing income.
First of all, what is a Master Limited Partnership? Master Limited Partnerships were established within the US Tax Code to enable smaller investors to be involved in operations with very costly up front costs such as for instance oil and gas pipelines that might be out of take the average investor without this type of partnership arrangement. Firms that choose to operate as MLPs are generally large, slow growing and stable and frequently have a monopoly within the territory that they operate. The assets generally produce a steady cash flow, but growth is slow and restricted to purchases of like facilities or new construction. MLPs don’t pay any corporate taxes, (often yielding higher returns as a result), rather income goes right to the machine holders pro rated by the amount of units they hold, and the machine holder is taxed at the individual’s tax rate. Each unit holder is a limited partner as the operation of the business is handled by the overall partner.
Don’t assume all company can qualify as an MLP. First the company must earn 90% or more of its income from natural resources (energy, mining, timber), minerals, commodities, real-estate, real-estate rents, or gains from dividends and interest. However, most MLPs Master Limiter currently are in the power area, specifically in oil products pipelines and natural gas pipelines. Generally oil product pipeline MLPs receive regulated fees for the transportation of product and are paid on volume unrelated to the buying price of the product being transported. This helps make them more stable. Natural gas pipeline operators also frequently run the gas gathering be well which gives them experience of the fluctuations in natural gas pricing. Many gas MLPs reduce the impact of price changes by hedging thereby establishing a more predictable cash flow.
MLPs make quarterly distributions which seem much like stock dividends however they’re quite different. Typically a quarterly distribution is classified as partially net income, and partially a reunite of capital (in the entire world of MLPs this return of capital is another term for depreciation or perhaps a depletion allowance). Generally, the Return of Capital represents the lion’s share of the distribution. The income part of the distribution is taxed at the individual’s normal tax rate as the return of capital segment reduces the fee basis. Which means that you don’t pay any taxes on the majority of the distribution until such time as you sell the units. In a regular taxable account this makes MLPs suitable for both long haul investors and people that intend on leaving their units with their heirs.
In an IRA, and other tax deferred accounts, there is one additional complication. That is, small segment of the distribution that is treated as net income is classified as UBTI (Unrelated Business Taxable Income) and if this portion exceeds $1000 annually it’s susceptible to income tax even in a tax deferred account, such as for instance an IRA, forcing the IRA to file a tax return. This issue is non existent for the average investor where in fact the UBTI will generally fall below the $1000 barrier. For investors with countless tens and thousands of dollars invested in MLPs in their IRAs, UBTI might be a more important factor. For individuals who are unsure it is very important to find tax advice from a CPA and other tax specialist.
Evaluating an MLP is different than evaluating a normal stock. Due to the huge outlays in capital equipment, and resultant typically large depreciation expenses, the normal earnings metrics aren’t befitting evaluating an MLP. Distributable cash flow is the most important single aspect in evaluating whether or not an MLP is appropriate for you. It is the origin for paying the quarterly distributions and provides cash for future expansion. It is very important to determine how consistent the distributable cash flow has been, and whether or not it’s grown. Like, Kinder Morgan Energy Partners, one of the finest known MLPs paid $0.475 per quarter in 2001, and just recently announced that it is likely to be paying $1.10 per quarter in 2010 up from $1.05 per quarter in 2009. It is this kind of consistent growth in distributions which have made MLPs a favorite of the more sophisticated yield investor.