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MLPs: The Essential Guide

MLPs, or Master Limited Partnerships, are an interesting option for income investors that can offer higher yields than most dividend stocks.

MLPs were formed in the U.S. in the early 1980’s. They are publicly traded partnerships. Back then, there were much higher top marginal tax rates than there are currently, and so investors were particularly interested in tax-advantaged businesses.

The MLP structure allowed businesses to spin off portions of their assets in a very tax-advantaged situation, and allowed individual investors to benefit as well. But the structure was so attractive in terms of taxation, that practically every business would want to be a MLP, and so in 1987, the government restricted which kinds of businesses can exist as MLPs.

For the most part, only real estate, natural resource, and interest/dividend income can now be held in MLPs. At least 90% of the income of the MLP must be from these qualifying sources.

Most of the MLPs I refer to in this guide invest in natural resource infrastructure. Some of the best ones, in my opinion, are the ones that invest in gas pipelines and other long-term infrastructure, since they can provide rather reliable cash flows for distribution growth. These projects have large capital expenditures, high barriers to entry, partial natural monopolies once they’re built (like a utility), and generate rather stable cash flows.

Core Reading:
The Structure of MLPs
What to Look for in a MLP

Should You Invest in MLPs?

There are advantages and disadvantages to investing in MLPs.

-Master Limited Partnerships can offer fairly high distribution yields that are also reasonably safe and reliable. When combined with some core dividend stocks, they can really boost the yield of a dividend portfolio.

-MLPs are fairly tax-advantaged since taxes are relatively modest and partially deferred.

-Although there are tax advantages, MLPs do complicate the tax filing, because you need to fill out an additional form. If you own quite a large investment, you may find yourself owing taxes in other states.

So, there are some pros and cons of investing in Master Limited Partnerships. Personally, I find them to be great investments as part of a diversified portfolio. I wouldn’t recommend investing in them if you only have a little bit of cash, but if you can commit a few thousand dollars to an investment, then MLPs might be an attractive option for you.

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