What are Master Limited Partnerships (MLPs)?

The investment world is filled with trading opportunities outside of your traditional stocks and bonds. You may not have heard about them as much, but each one offers their own set of benefits and risks. Take, for example, a master limited partnership.

A master limited partnership (MLP) is a publicly traded partnership that shares elements of a limited partnership and a corporation.

Essentially, an MLP is made up of two partnership components:

– General Partnerships: These guys take care of the day-to-day management aspect of the business, and usually invest very little (normally around 2%).

– Limited Partners: These guys invest closer to 98% of the partnership, purchasing the shares that generate capital. They are usually paid by receiving distributions from the MLP on a quarterly basis.

Since Master Limited Partnerships aren’t incorporated, their shares are a little different and are actually referred to as units, making the limited partners unitholders.

In 1987, congress limited the use of Master Limited Partnerships to real estate and energy companies. Due to this change, MLPs are now only found in these slow-growing industries.

Benefits of Master Limited Partnerships

The way Master Limited Partnerships operate provides additional income for their investors. The business structure takes advantage of the cash flow, when all available cash is distributed to investors.

Another selling point of Master Limited Partnerships is that in many cases, they may not have to pay federal taxes as long as at least 90% of their income is qualifying. This means that they need earn income from production, exploration or production of natural resources or real estate.

Limited partners can also deduct depreciations and depletions of the business as taxable income, significantly decreasing the amount they may be taxed at the end of each quarter.

Investors also love MLPs because they are considered low risk. Because their operations take place in slow-moving industries, a company could be deemed profitable for the length of their contract, which could span years.

Tax Complications of Master Limited Partnerships

Despite all of their benefits, there are some drawbacks to MLPs. The taxes alone can get pretty complicated. Unitholders only pay for their own share of the partnership’s income taxes, which can get messy come tax season.

Also, there’s the issue of unrelated business taxable income (UBTI). This occurs when a unit holder’s retirement account exceeds a certain threshold. Once they hit that magic figure, they can be taxed on their retirement savings. Since the point of retirement is saving up as much as you can before stopping work, putting a cap on the amount you should earn almosts defeats the purpose of saving for retirement.

While MLPs do present a unique opportunity to earn more for investors, they aren’t exactly cut and dry. If you prefer to focus on more straightforward investments, stocks and bonds may work better for you.