Investing in MLPs – Master Limited Partnerships: Ryan Giannotto, CFA, discusses investing in MLPs – Master Limited Partnerships and what you can do with them to generate income in retirement.

An MLP is a business venture in the form of a publicly-traded limited partnership. A master limited partnership combines the tax benefits of a private partnership with the liquidity of a publicly-traded company. A master limited partnership trades on national exchanges. MLPs generally experience cash flow stability and are required by the partnership agreement to distribute a set amount of cash to investors. The structure of MLPs can help reduce the cost of capital in capital intensive businesses. The first MLP was organized in 1981 but by 1987 the US Congress effectively limited the use of them to natural resources and the real estate sector. MLPs do not pay federal income taxes.

More about Investing in MLPs

A master limited partnership (MLP) is a publicly traded partnership that combines the tax benefits of a partnership with the liquidity of publicly traded securities. MLPs are typically formed by businesses operating in the energy, real estate, natural resources, or infrastructure sectors, although they can be found in other industries as well.

Here are some key characteristics of master limited partnerships:

Structure: MLPs are structured as limited partnerships, consisting of two types of partners: general partners and limited partners. The general partner manages the operations of the partnership and is usually a corporation, while limited partners provide capital and have limited liability for the partnership’s debts.

Tax Treatment: One of the primary advantages of MLPs is their tax treatment. Like other partnerships, MLPs are not subject to corporate income tax at the federal level. Instead, income generated by the MLP is passed through to the individual partners and taxed only at the partner level. This “pass-through” taxation can result in significant tax benefits for investors, as they avoid double taxation on income distributed by the partnership.

Cash Distributions: MLPs typically distribute the majority of their cash flow to investors in the form of quarterly distributions. These distributions are often substantial and can provide investors with a steady stream of income. However, it’s important to note that not all distributions are guaranteed, and they may fluctuate based on the partnership’s financial performance.

Limited Liquidity: While MLP units are publicly traded on stock exchanges, they can be less liquid than traditional stocks due to their unique structure and limited investor base. As a result, buying and selling MLP units may involve higher transaction costs and wider bid-ask spreads.

Sector Focus: Many MLPs operate in the energy sector, particularly in the midstream segment, which includes businesses involved in the transportation, storage, and processing of oil, natural gas, and other energy products. However, MLPs can also be found in sectors such as real estate, infrastructure, and telecommunications.

Regulatory Requirements: MLPs are subject to specific regulatory requirements set forth by the Internal Revenue Service (IRS) and the Securities and Exchange Commission (SEC). To qualify as an MLP, a partnership must derive a significant portion of its income from qualifying sources, such as natural resources or real estate, and must distribute a minimum percentage of its income to investors.

Overall, investing in master limited partnerships can offer investors the potential for attractive yields, tax benefits, and exposure to diverse sectors of the economy. However, they also come with unique risks, including sensitivity to commodity prices, regulatory changes, and interest rate fluctuations. As with any investment, it’s essential to conduct thorough research and consult with a financial advisor to determine whether MLPs align with your investment goals and risk tolerance.

Watch this finStream video to learn more about investing in MLPs – Master Limited Partnerships.