Menu
sharewise sharewise
Log in
Sign up
Log in
Sign up
Microsoft strongly encourages users to switch to a different browser than Internet Explorer as it no longer meets modern web and security standards. Therefore we cannot guarantee that our site fully works in Internet Explorer. You can use Chrome or Firefox instead.

Dictionary

Understanding Master Limited Partnerships (MLPs)

A Master Limited Partnership (MLP) is a unique type of business structure combining the benefits of both a partnership and a corporation. Generally used within the United States, MLPs are often preferred by investors due to their tax advantages and the potential for high income. While most commonly associated with the energy industry, MLPs can be found in a variety of sectors such as real estate, finance, and transportation.

The Structure of an MLP

An MLP consists of a general partner (GP) and a number of limited partners, also known as unit holders. The general partner manages the MLP's operations and has a voting stake in the partnership. In contrast, limited partners have no say in the management but receive a portion of the partnership's income.

This unique structure allows MLPs to avoid the "double taxation" that often affects corporations. Instead of being taxed at both the corporate level and the shareholder level, MLPs pass their earnings directly to the partners, meaning profits are only taxed once when the limited partners receive their share of the income.

Investment Opportunities of MLPs

One reason investors may choose to invest in an MLP is for the potential to receive stable and often high income. As MLPs mainly deal with the transportation, storage, and processing of natural resources, their income is typically grounded in long-term contracts, providing consistency in their cash flow.

An investor can buy and sell units of an MLP on a stock exchange, just like shares of a publicly traded corporation. This accessibility makes it an attractive option for investors seeking to diversify their portfolios with exposure to sectors that make use of the MLP structure.

Another benefit of investing in MLPs is the yield they often provide. Because MLPs are required to distribute the majority of their earnings to limited partners, their yields are typically higher than those of other investments.

Tax Benefits and Considerations

The most appealing aspect of MLPs is the tax advantages they offer. As previously mentioned, MLPs avoid the double taxation that corporations face. This means that the distributed profits end up being taxed only at the individual limited partner level.

Moreover, because an MLP's distributions are often considered a "return of capital," they can further lower an investor's tax liability. This means a portion of the distributions may not be taxed at all, instead being subtracted from the investor's original investment cost basis. As a result, capital gains taxes may be deferred until the investor sells their units in the partnership.

However, it is important to note that investing in MLPs may come with additional tax-complexity. Investors will receive a Schedule K-1 tax form rather than a 1099-DIV, which is typically used when receiving dividends from a corporation. This added complexity is something potential investors need to consider before deciding to invest in MLPs.

Risks Associated with MLPs

While there are numerous benefits of investing in MLPs, there are also some risks that should be taken into account. The following factors might potentially impact the performance of MLP investments:

  • Industry concentration: As many MLPs are in the energy sector, they are vulnerable to fluctuations in energy prices and changes in the regulatory environment. Diversification within a portfolio is key to mitigating this risk.
  • Interest rates: MLPs often rely on external financing, which can be influenced by increasing interest rates. Higher borrowing costs can impact the profitability of an MLP in the long run.
  • Tax law changes: Any changes to tax laws that affect the partnership structure or the tax treatment of MLPs could diminish the advantages offered by these investments.

Conclusion

In summary, a Master Limited Partnership (MLP) is a versatile and unique investment vehicle that combines elements from both partnerships and corporations. Investors who decide to purchase units of an MLP may benefit from high income potential, stable cash flows, and tax advantages. However, the risk of industry concentration, fluctuating interest rates, and potential tax law changes should be carefully considered before making an investment. With proper research and assessment, MLPs can provide an opportunity for investors to achieve growth and generate income within their investment portfolios.

Feedback