Today let’s move over into the long-term investing lane and talk about a little understood or even mentioned vehicle. It’s the Master Limited Partnership or MLP for short.
Before going into the details, the first thing to know is that these Master Limited Partnerships are publicly traded just as shares of stock or ETF’s are.
Master Limited Partnership Definition: An MLP is a business organization that exists as a publicly traded limited partnership.
This format is something of a hybrid business structure that combines elements of a corporation and a partnership. Now MLP’s do not pay federal income tax on the entity level as corporations do.
The general partners run the day-to-day affairs of the company just as officers of a corporation or managing team of a mutual or exchange traded fund do.
The investors are the limited partners and exist as a body in terms of rights like stock shareholders do.
Rather than being referred to as shares, the investor(s) in a Master Limited Partnership buy units.
What Can a Master Limited Partnership Invest In?
In 1987 Congress set up rules that limit MLP’s to invest only in natural resources and real estate.
MLP’s historically deliver higher returns than stock and have also been more volatile. Because of this MLP’s should be used as a part of an overall portfolio and asset allocation strategy.
Why mess with MPL’s at all? Because of the potential for high returns and for income.
MLP’s typically often offer much higher yields than stocks, which can be extra attractive for income investors.
Master Limited Partnership Stocks
Here is a brief list of several of the more well know MLP’s with their current yields at the time of this writing. Double check the current yield with your favorite charting software or broker.
- MPLX – 11.17%
- ET – 8.94%
- EPD- 8.26%
- MMP – 9.86%
- BPY – 7.50%
There are also exchange traded funds that specialize in the MPL area.
One of these is AMLP (Alerian MLP ETF).
This fund itself sports a 10.26% dividend yield.
Dividend income investors often employ MLP’s to help boost the income stream provided by their portfolios.
Why Are MLP’s Not Used by More Individual Investors?
There are several reasons beyond simply having less name recognition and being less understood.
Let’s focus on two key things:
1. Master Limited Partnership tax reporting takes an extra step. What I mean is an MLP generates a K-1 tax form rather than the standard 1099 that corporations do.
The K-1 is one more item that needs to be considered when it comes time to do your yearly tax returns.
TurboTax and other tax software packages handle K-1’s quite well.
If you have a preparer do your returns, they will handle them. Some do not charge and others do. So, this is an issue to consider but likely not a huge deterent.
2. There can be tax ramifications if you have very large MLP holdings. This is not a factor for the majority of individual investors.
The issue involves an element that is reported on the K-1 known as UBTI or unrelated business taxable income.
This is income that may be generated by the MLP that is outside the scope of the business’s usual activities as defined in the MLP charter.
These are often minimal or nonexistent and therefore not a direct issue to most investors.
What Does the IRS Say About UBTI?
The IRS says that if UBTI in a single account for a single year is higher than $1,000 (hard to do), a UBTI tax is triggered.
This tax can also apply in an IRA.
For practical purposes, if one kept their MLP holding in a single tax-deferred account under $50,000 (estimated) they are likely to not have any issues, however, it’s best to seek advice from an accountant or tax specialist familiar with your situation.
It is evident why most people will not consider using MLP’s at all, Master Limited Partnership taxation.
Or put another way…
Primarily, it’s because of the potential for an uncommon tax rule to become a factor. I have owned MLP’s myself and never had any issues, however, again it’s best to seek professional advice for your current situation.
If you are not scared off by these factors then you may find MLP investing to be rewarding.
Starting with just one is a good way to go, or if you want to avoid the whole K-1 situation while still enjoying significantly higher yields then an MLP exchange traded fund may be the way to go.
Closing Thoughts
Because many MLP’s are involved with midstream energy transportation they, as well as the energy sector as a whole, have been under price pressure for several years.
As an example, Enterprise Products Partners (EPD) has paid an uninterrupted dividend for 22 straight years.
The current dividend of 8.26% is 31% above its 5-year average, yet their operating margin was higher in 2020 (the crazy year) than in 2019.
MLP’s are not for everyone but they can add some zest to the portfolios of no longer novice investors.
