Master Limited Partnerships (MLPs), where an investor is a partner rather than a shareholder, is similar to a stock in many ways.
It is traded on the stock exchange, has a ticker symbol, you can buy or sell it at any time during the trading day and can go up or down based on factors similar to a stock. It combines the tax benefits of a limited partnership with the liquidity of public traded securities. There are several differences in MLPs from stocks.
Since the payment is a distribution rather than a dividend, the IRS treats MLPs differently. If you are in the 25% to 33% tax bracket, you will pay a 15% tax rate and if your income is about $250,000, you pay an additional 3.8% in taxes. A large amount or all of this distribution is considered return of capital, which is not taxable as income. Instead, that return of capital reduces your cost basis in the MLP. Overall, you get to exclude the annual income from distributions in return for reducing your cost basis in the position.
For example, if you buy KMP as an MLP for $40, it pays a distribution of $1, all of which is return on capital. At the end of the year, you will not pay taxes on your $1 distribution. Instead, your cost basis goes down to $39 ($40-$1=$39). Further, if you hold on to the investment for five years and you collect $5 in distributions, your cost basis will now be $35 ($40-$5=$35). Now, let’s assume you sell your stake in the MLP for $45. You will be taxed on your $10 capital gain ($45 selling price - $35 adjusted cost basis = $10 capital gain). So, you will still have to pay taxes on the capital gain, but for five years, you collected tax-deferred income.
Another great benefit of MLPs is the benefit for your heirs. In the case that you pass away, your beneficiaries will receive a break. They inherit the MLP’s cost basis at the current market value, meaning you collect the income without ever paying taxes and the beneficiary inherits the stock with no capital gains or tax. MLPs are an efficient way to invest nonretirement dollars, where the distribution percentage is so good that it is used often in retirement accounts as well.
Another source of worthwhile investments is the oil and natural gas route, as it does not depend on the price of the product, but rather on the increasing demand for these resources that our country is consuming. Since these are some of our country’s most plentiful resources, it is an outstanding way to invest in infrastructure that our country needs. Technology today allows for an increased use of natural gas rather then coal for energy production; this resource will continue to flow happily through these pipeline investments.
— Registered Representatives offer securities through Securities America, Inc. Member FINRA / SIPC.
— Article written by Securities America, Inc. for distribution by Michael Mullis.Investment Advisor
— Representatives offer financial advice through Securities America Advisors, Inc.