By Christopher Pugh, Fall 2014 Student Intern
A Master Limited Partnership (MLP) is a publicly traded investment that is viewed as an aggregate of its partners rather than as one corporate entity. This allows income to “pass-through” and the individual partners are responsible for their own income tax, so MLPs are becoming more popular with investors looking to avoid the “double-taxation” of paying both corporate and personal taxes. Be sure to talk with a tax advisor and do your research on any tax-related aspects of investing.
MLPs are formed by two types of partners. First, there are limited partners (the investors) who contribute capital to the venture and then receive distributions from the profits. Second, there is a general partner who manages the MLP’s daily operations and trading and is paid based on the partnership’s performance. The advantage of this type of investment partnership is that the taxes on the profits are deferred until a disbursement of funds is made to the limited partners. This combines the liquidity benefits of a publicly traded stock with the tax benefits of a limited partnership. Put differently, a limited partner can liquidate their interests in the MLP at any time without the same kind of hassle that cashing out a tax-deferred IRA requires, while still enjoying the same tax-deferment benefits of an IRA.
A key distinguishing feature of an MLP is that its assets must contain at least 90% real estate, natural resources or commodities. Because of this requirement, MLPs are risky. In fact, one of the major disadvantages of an MLP is that the limited partners (investors) do not usually know the specifics and risk profiles of each investment the general partner makes. Further, investors can confuse the partnership’s distribution rates (how much is paid out to limited partners) with their actual total returns. This confusion can occur because sometimes some of the principal investment is paid out in the distribution checks giving the appearance that the partnership is more profitable than it actually is. Additionally, because most of the partnership’s profits are paid out in distribution checks to limited partners, the only way to achieve growth of the MLP is to issue more stock or take on debt−thereby increasing investor risk. Check out the link below to read more about MLPs: FINRA Investor Alert on MLPs and Closed End Funds.