A Primer On Master Limited Partnerships

An Introduction To A Unique Asset Class

This week I will be writing on two partnerships that I find interesting, Enterprise Products Partners EPD 0.00%↑ and Natural Resource Partners NRP 0.00%↑. I have owned Enterprise Products Partners for a couple years, and I think it is a relatively low risk way to own a piece of the US energy infrastructure at a discount. I wasn’t able to buy Natural Resource Partners, but it is still on my watchlist as an interesting and undervalued situation. Today I will be discussing several key differences between Master Limited Partnerships and C-corporations.

---

Master Limited Partnerships

Like other partnerships, MLPs have general partners that manage the partnership, and limited partners, that invest in the partnership. MLPs combine the pass-through tax structure of other partnerships with the public market liquidity of common stocks. There are no taxes at the partnership level. Instead, the limited partners pay income taxes on their portion of the partnership’s earnings. Due to the tax structure, MLPs are primarily found in the natural resource sector and have a couple things investors should be aware of before investing in MLPs.

Units vs. Shares

One of the first differences is that investors own units in the partnership, instead of shares in a corporation. There are differences between being a unitholder and a shareholder, but owning units in a partnership creates different tax problems than owning a regular stock.

Distributions vs. Dividends

One of the best reasons to own an MLP is the tax-deferred nature of the distributions. Unitholders do not pay income tax on distributions received. A portion of the distribution is treated as return of capital and it reduces your cost basis. This potentially means a larger tax hit on the back end if you sell the units, but in the meantime, MLPs offer a tax-advantaged income stream that is usually much higher than the yield on the average stock or the interest rate on bonds.

As a side note, MLPs are not a good fit for retirement accounts. It creates a bigger headache than it is worth, and if you get the tax benefits in a regular brokerage account, it makes more sense to hold units of an MLP in a standard account.

K-1 Tax Forms

While the distribution is a huge advantage of MLPs, the drawback of partnerships is the K-1 tax form the unitholders have to fill out at tax time. My tax accountant complains about them (which is why I only have on MLP personally), and I think investors should be picky their spots with MLPs. My basic thought on it is that if you can buy enough units of an MLP to pay for the additional tax hassle, I think the MLP space is an interesting sector to look at, especially for income focused investors. Readers that are interested in MLPs should do their own research (and consult a tax expert), but I would advise against buying just 10 or 100 units of an MLP. The potential return from a small position isn’t enough to justify the additional hassle.

---

These are just some of the basics with Master Limited Partnerships, but it should provide a baseline that will be helpful for my posts later this week on Enterprise Products Partners and Natural Resource Partners. Again, investors should be fully aware of the nuances of buying and owning MLPs before buying units. If you want a link to a good page for MLPs 101, you can follow this link to Investopedia.