Master Limited Partnerships are commonly referred to as MLPs. It is a corporate structure authorized by federal legislation, and allowed for businesses in certain industries.
Ninety percent of the MLP's revenue must come from qualifying sources, usually the production, processing or transportation of products such as oil, gasoline, natural gas or coal.
Investors can investin MLPs by buying units of ownership in a brokerage transaction just likea stock trade.
Units are commonly traded on the New York Stock Exchange and the NASDAQ market.
Why invest in MLPs? Well, past performance shouldn't ever be the main reason to invest, but this market segment has proven to be one of the best performing asset classes over the last three, five, and 10 year periods of time.
Fundamentals of the move toward less dependence on foreign sources of energy bode well for the future growth of companies in the business of producing and transporting energy-related natural resources from their point of extraction to the refining facilities or final distribution facilities.
Unit prices of MLPs fluctuate in a similar manner to stocks and investors should understand the potential for volatility before investing.
Shareholders -- technically known as "limited partners" -- receive an immediate reward of a reasonably high distribution rate, typically in the 5 to 7 percent range. This distribution represents the limited partners' share of the profits from operations and tends to be significantly tax deferred due to the pass-through of depreciation expense of the pipelines or production facilities.
This current tax benefit is not a total avoidance of taxes, however, and the cost basis of the limited partners units is reduced by the amount of the tax shelter, which means that the capital gains when units are ultimately sold will be higher.
Since long-term capital gains are generally taxed or lower than normal income rates, there is still a significant benefit.
In addition to the current income and tax benefits, over time the value of ownership units of MLPs has tended to rise over time similar to the values of good quality common stocks. One interesting aspect of the structure of MLPs is that the general partner's level of profit can only go up when the limited partner's level of distribution goes up. This is a unique feature that aligns the interests of the people running the day-to-day operation with the investors in the enterprise, like you and me.
One word of caution related to investing in MLPs inside IRAs or other tax qualified accounts.
Income from MLPs inside these retirement accounts greater than $1,000 a year triggers a clause known as "un-related business income" and you would have to pay taxes on the income even though it was produced in your tax-deferred retirement account.
A development in the last few years helps avoid un-related business income. When MLPs are contained in a mutual fund or exchange traded fund, there is no tax impact from the income inside IRAs, no mater how large the level of income is.
Several mutual funds and exchange-traded funds are now availablefor everyday investors, providing diversification, professional management, and the ability to invest inside of retirement accounts, all while enjoying the benefits of this unique asset class.
Tom Breiter, president of Breiter Capital Management, can be reached at email@example.com.