Confusion and misunderstanding provides opportunities for folks who are willing to make the effort to dig into the detail and learn the fundamentals of difficult topics. Such as for instance a befuddled 7th grader whose eyes glaze over when the math teacher first broaches the subject of algebra, many investors shy far from Master Limited Partnerships because they cannot fit standard for stock investments, have yields which can be “too much,” aren’t measured by the same metrics as other equities, may not be befitting IRAs, and generally are “more difficult” to understand than their other investments. However, for those prepared to take some time to examine slightly, they’ll find that the planet of MLPs is not totally all that complicated and can give you a wonderful opportunity for a long term steady and growing income.
First of all, what’s a Master Limited Partnership? Master Limited Partnerships were established within the US Tax Code allow smaller investors to take part in operations with very expensive at the start costs such as for instance oil and gas pipelines that would be out of grab the typical investor without such a partnership arrangement. Firms that choose to work as MLPs are generally large, slow growing and stable and frequently have a monopoly within the territory which they operate. The assets generally produce a consistent cash flow, but growth is slow and limited 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 directly to the machine holders pro rated by the number of units they hold, and the machine holder is taxed at the individual’s tax rate. Each unit holder is really a limited partner while the operation of the company is handled by the typical partner.
Don’t assume all company can qualify as an MLP. First the organization must earn 90% or maybe 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 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 price of the product being transported. This tends to make them more stable. Natural gas pipeline operators also frequently run the gas gathering work as well which provides them exposure to the fluctuations in natural gas pricing. Many gas MLPs decrease the impact of price changes by hedging thereby establishing a more predictable cash flow. Gain Reduction
MLPs make quarterly distributions which seem just like stock dividends however they’re quite different. Typically a quarterly distribution is classified as partially net income, and partially a return of capital (in the planet of MLPs this return of capital is another term for depreciation or a depletion allowance). Generally, the Return of Capital represents the lion’s share of the distribution. The income portion of the distribution is taxed at the individual’s normal tax rate while the return of capital segment reduces the fee basis. Which means that you don’t pay any taxes on many the distribution until such time as you sell the units. In a typical taxable account this makes MLPs perfect for both long term investors and people who intend on leaving their units to their heirs.
Within an IRA, or other tax deferred accounts, there is one additional complication. That is, small segment of the distribution that’s treated as net income is classified as UBTI (Unrelated Business Taxable Income) and if this portion exceeds $1000 annually it is at the mercy of income tax even yet in a tax deferred account, such as for instance an IRA, forcing the IRA to file a tax return. This problem is non existent for the typical investor where the UBTI will generally fall below the $1000 barrier. For investors with countless tens of thousands of dollars committed to MLPs within their IRAs, UBTI might be a more important factor. For many who are unsure it is very important to get tax advice from the CPA or other tax specialist.
Evaluating an MLP is unique of evaluating an average stock. Because of the huge outlays in capital equipment, and resultant typically large depreciation expenses, the conventional earnings metrics aren’t befitting evaluating an MLP. Distributable cash flow is the most important single element in evaluating whether or not an MLP is suitable for you. It is the foundation for paying the quarterly distributions and provides cash for future expansion. It is very important to ascertain how consistent the distributable cash flow has been, and whether or not it has grown. As an example, Kinder Morgan Energy Partners, one of the greatest known MLPs paid $0.475 per quarter in 2001, and recently announced that it will soon be paying $1.10 per quarter in 2010 up from $1.05 per quarter in 2009. It is this sort of consistent growth in distributions that have made MLPs a popular of the more sophisticated yield investor.