Confusion and misunderstanding can offer opportunities for people who are willing to make the effort to dig in to the detail and learn the fundamentals of difficult topics. Just like a befuddled 7th grader whose eyes glaze over once the math teacher first broaches the subject of algebra, many investors shy away from Master Limited Partnerships because they do not fit typical for stock investments, have yields which are “too high,” are not measured by the same metrics as other equities, might not be befitting IRAs, and generally are “more difficult” to know than their other investments. However, for those prepared to make an effort to review slightly, they’ll find that the planet of MLPs is not all that complicated and can offer 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 to enable smaller investors to participate in operations with very expensive in advance costs such as for example oil and gas pipelines that might be out of take the average investor without such a partnership arrangement. Companies that choose to work as MLPs are generally large, slow growing and stable and often have a monopoly within the territory which they operate. The assets generally produce a regular cash flow, but growth is slow and limited by purchases of like facilities or new construction. MLPs don’t pay any corporate taxes, (often yielding higher returns as a result), rather income goes straight to the system holders pro rated by the amount of units they hold, and the system holder is taxed at the individual’s tax rate. Each unit holder is really a limited partner whilst the operation of the business is handled by the general partner.
Don’t assume all company can qualify as an MLP. First the company must earn 90% or maybe more of its income from natural resources (energy, mining, timber), How Much Gain Reduction Should You Use On The Master Limiter? minerals, commodities, real estate, real estate rents, or gains from dividends and interest. However, most MLPs currently have been in the vitality 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 tag on the merchandise being transported. This tends to 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 reduce steadily the impact of price changes by hedging thereby establishing an even more predictable cash flow.
MLPs make quarterly distributions which seem much like stock dividends however they are 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 even a depletion allowance). Generally, the Return of Capital represents the lion’s share of the distribution. The income percentage of the distribution is taxed at the individual’s normal tax rate whilst the return of capital segment reduces the fee basis. Which means you don’t pay any taxes on the majority of the distribution until such time as you sell the units. In a typical taxable account this makes MLPs ideal for both longterm investors and folks who anticipate leaving their units to their heirs.
In a IRA, and other tax deferred accounts, there’s one additional complication. That is, the smaller 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’s at the mercy of income tax even yet in a tax deferred account, such as for example an IRA, forcing the IRA to file a tax return. This problem is non existent for the average investor where in fact the UBTI will generally fall below the $1000 barrier. For investors with countless a large number of dollars dedicated to MLPs in their IRAs, UBTI may be a more important factor. For people who are unsure it is very important to find tax advice from the CPA and other tax specialist.
Evaluating an MLP is different than evaluating an average stock. Due to the huge outlays in capital equipment, and resultant typically large depreciation expenses, the normal earnings metrics are not befitting evaluating an MLP. Distributable cash flow is the most crucial single element in evaluating whether an MLP is appropriate for you. It’s 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 it has grown. For instance, Kinder Morgan Energy Partners, one of the best known MLPs paid $0.475 per quarter in 2001, and just recently announced that it will soon be paying $1.10 per quarter in 2010 up from $1.05 per quarter in 2009. It’s this type of consistent growth in distributions which have made MLPs a popular of the more sophisticated yield investor.