Confusion and misunderstanding can offer opportunities for those who are willing to make the effort to dig into the detail and learn the fundamentals of difficult topics. Like a befuddled 7th grader whose eyes glaze over when the math teacher first broaches the subject of algebra, many investors shy from Master Limited Partnerships because they don’t fit standard for stock investments, have yields which can be “excessive,” aren’t measured by the same metrics as other equities, may not be befitting IRAs, and generally are “more difficult” to comprehend than their other investments. However, for anyone prepared to take some time to study a bit, they’ll 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.
To start with, what is a Master Limited Partnership? Master Limited Partnerships were established within the US Tax Code to enable smaller investors to participate in operations with very costly at the start costs such as oil and gas pipelines that could be out of reach for the typical investor without this kind of partnership arrangement. Firms that choose to use as MLPs tend to be large, slow growing and stable and often have a monopoly within the territory they operate. The assets generally produce a constant cash flow, but growth is slow and limited by purchases of like facilities or new construction. MLPs don’t pay How Much Gain Reduction Should You Use On The Master Limiter? any corporate taxes, (often yielding higher returns as a result), rather income goes straight to the unit holders pro rated by how many units they hold, and the unit holder is taxed at the individual’s tax rate. Each unit holder is really a limited partner whilst the operation of the business enterprise is handled by the general partner.
Its not all company can qualify being an MLP. First the organization 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 currently have been in the energy 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 item being transported. This can make them more stable. Natural gas pipeline operators also frequently run the gas gathering work as well gives 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.
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 get back of capital (in the entire world 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 part of the distribution is taxed at the individual’s normal tax rate whilst the return of capital segment reduces the price basis. Which means that you don’t pay any taxes on many the distribution until such time as you sell the units. In a regular taxable account this makes MLPs well suited for both longterm investors and folks who anticipate 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 subject to income tax even yet in a tax deferred account, such as an IRA, forcing the IRA to file a tax return. This issue is non existent for the typical investor where in fact the UBTI will generally fall below the $1000 barrier. For investors with a huge selection of a large number of dollars invested in MLPs inside their IRAs, UBTI can be a more important factor. For individuals who are unsure it is important to seek tax advice from the CPA or other tax specialist.
Evaluating an MLP is diverse from evaluating a typical 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 crucial single element 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 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 best known MLPs paid $0.475 per quarter in 2001, and only recently announced so it is going 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 that have made MLPs a popular of the more sophisticated yield investor.