Master Limited Partnerships (MLPs)
Master Limited Partnerships (MLPs) are comparable to real estate investment trusts (REITs) because they are not subject to income tax. Their shares are traded on major stock indices, like normal stocks. There are, however, some significant differences between the two. REITs are a form of corporations, while MLPs are considered partnerships. The general partner of the MLP is in charge of operating the partnership, the investors in the MLP are considered the limited partners.
MLPs receive a form of preferred tax treatment. MLPs are not subject to income tax. Any income generated is distributed or allocated between all the partners according to their interest percentage ownership. In order the MLP to qualify for these generous tax benefits, at least 90% of it’s income must be generated from activities in real estate, commodities, or natural resources. These could include, energy production and transportation, mining and even lumber. A common question arises as to whether an MLP can be placed in an IRA, this can become a complicated issue and you may not receive the full benefit that was intended.
When looking into different MLPs, you should also consider the role of the general partner (GP). The GP will normally own at least 2% of the general partnership interest along with a varying amount of limited partnership interest. The GP will also take a percentage scrape off the top of any MLPs cash flow. This means the GP gets his piece before any of the limited partners get their distributions. This is called an IDR, or incentive distribution rights. The incentive being that the greater the success of the MLP the more money the GP earns.
While MLPs have great tax benefits, some are more exposed risk than others. For example an MLP focused on mining and exploration is more exposed to the price of crude or precious metals. Where as a pipeline operator is not exposed to the price fluctuations of a barrel of oil, yet they do not lack for any business.
Master Limited Partnerships can be a very lucrative vehicle for investing. However, be sure to research into each sector, way out the risks involved in each. Long term portfolio building should be focused on stability and growth.
You can read Investopedia’s description of Master Limited Partnerships.