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Master Limited Partnership (MLP)

Master Limited Partnership (MLP)

What Is a Master Limited Partnership (MLP)?

A master limited partnership (MLP) is a business venture as a publicly-traded limited partnership. It joins 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 disseminate a set amount of cash to investors. Their structure can likewise assist with decreasing the cost of capital in capital-escalated businesses, like the energy sector.

The first MLP was organized in 1981. Notwithstanding, by 1987, Congress actually limited the utilization of them to the real estate and natural resources sectors. These limitations were put into place out of a concern over too much lost corporate tax revenue. MLPs don't pay government income taxes.

Understanding Master Limited Partnerships (MLPs)

The MLP is a hybrid legal entity that consolidates components of two business structures โ€” a partnership and a corporation. First of all, it is viewed as the aggregate of its partners as opposed to a separate legal entity (just like with a corporation).

Second, it technically has no employees. The general partners are responsible for offering all essential operational types of assistance. General partners typically hold an estimated 2% stake in the venture and have the option to increase their ownership.

A MLP issues units rather than shares. Be that as it may, these units are many times traded on national stock exchanges. Subsequently, they are a liquid security. Traditional partnerships can't offer a similar level of liquidity.

Since a MLP's publicly traded units are not stock shares, the people who invest in MLPs are generally alluded to as unitholders, as opposed to shareholders. The people who buy into a MLP are called limited partners. These unitholders are allocated a share of the MLP's income, deductions, losses, and credits.

MLPs have two classes of partners:

  1. Limited partners are investors who purchase shares in the MLP and give the capital to the entity's operations. They receive periodic distributions from the MLP, normally every quarter. Limited partners are otherwise called silent partners.
  2. General partners are the owners who are responsible for dealing with the everyday operations of the MLP. They receive compensation in light of the partnership's business performance.

Tax Treatment of MLPs

Pass-Through Tax Consequences

A MLP is treated as a limited partnership for tax purposes, which is a huge tax advantage for investors. A limited partnership has a pass-through, or flow-through, tax structure. This means that all profits and losses are passed through to the limited partners. The MLP itself pays no taxes on its revenues, as most incorporated businesses do. All things considered, the limited partners pay income taxes just on their portions of the MLP's earnings.

Further, deductions, like depreciation and depletion, additionally pass through to the limited partners. Limited partners can utilize these deductions to reduce their taxable income.

To keep up with its pass-through status, no less than 90% of the MLP's income must qualify income. Qualifying income incorporates income realized from the exploration, production, or transportation of natural resources or real estate.

All in all, to qualify as a master limited partnership, a company must generate everything except 10% of its revenues from natural resources or real estate activities. This definition of qualifying income reduces the sectors where MLPs can operate.

Deferred Taxes and the Capital Gains Tax Rate

Quarterly distributions from the MLP are not unlike quarterly stock dividends. Nonetheless, a portion of a distribution is treated as a return of capital (ROC) instead of dividend income. In this way, the unitholder doesn't pay income tax on the distribution. All things considered, the distribution reduces the cost basis of units.

The distributions remain tax-deferred until unitholders sell their interests in the MLP. Then, the difference between cost basis and sale price is taxed at a combination of the ordinary income tax rate (on the return of capital distribution) and the capital gains tax rate (on the appreciation of the units since purchase). This offers a critical, extra tax benefit.

MLPs are taxed as partnerships not corporations. So their profits are not subject to the double taxation that corporations face. Corporations pay corporate tax and afterward the shareholders must pay personal taxes on the income from their holdings.

Advantages and Disadvantages of MLPs

Like any investment, MLPs have their advantages and disadvantages. MLPs may not work for all investors. An investor must gauge the disadvantages against the benefits of holding units of MLPs before they invest.

Advantages

  1. MLPs are known for offering slow yet consistent investment returns. The slow returns stem from the fact that MLPs are in many cases in slow-developing industries, like pipeline construction. This slow and consistent growth means MLPs are low risk. They earn a stable income frequently founded on long-term service contracts. MLPs offer consistent cash flows and reliable cash distributions.
  2. The cash distributions of MLPs normally become somewhat quicker than inflation. For limited partners, 80% to 90% of the distributions are in many cases tax-deferred. Overall, this allows MLPs to offer attractive income yields โ€” frequently substantially higher than the average dividend yield of equities. Additionally, with the flow-through entity status (and the shortfall of double taxation), more capital is accessible for future activities. The availability of capital keeps the MLP competitive in its industry.
  3. Further, for the limited partner, cumulative cash distributions could surpass the portion taxed at the capital gains rate whenever units are sold.
  4. Limited partners' liability for a MLP's obligations and obligations is limited to the amount of their capital contribution.
  5. Until the 2017 tax cuts act benefit lapses in 2025, investors can deduct 20% of their distributions from their taxable income, decreasing the tax they would some way or another pay.
  6. There are benefits to involving MLPs for estate planning, too. At the point when unitholders gift or transfer the MLP units to beneficiaries, both unitholders and beneficiaries abstain from paying taxes during the hour of transfer. The cost basis will straighten out in light of the market price during the hour of the transfer assuming the transfer happens due to death. There is no step-up in basis on the off chance that the MLP's units are gifted. Ought to the unitholder kick the bucket and the investment pass to heirs, the units pass tax free and honest evaluation is determined to be the value as of the date of death.

Disadvantages

  1. MLPs are incredibly tax-efficient for investors. Notwithstanding, the filing requirements for this business structure are complex. A MLP's income, deductions, credits, and different things are itemized every year on an Internal Revenue Service (IRS) Schedule K-1 form that is shipped off the investor. The K-1 can be convoluted and make extra work for investors (or the tax experts they hire).
  2. MLP investors are required to pay state income taxes on their allocated portion of income in each state in which the MLP operates (which can be mutiple). This can increase their costs.
  3. Another tax-related disadvantage of MLPs is that you can't utilize a net loss (a bigger number of losses than profits) to offset other income. In any case, net losses might carry forward to the following year. At the point when you at last sell your units as a whole, a net loss can then be utilized as a deduction against other income.
  4. MLPs have limited upside potential. Nonetheless, this may be expected from an investment that ought to create a slow yet dependable income stream north of several years.

Pros

  • Steady income

  • Relatively low risk

  • Tax-advantaged treatment

  • Liquidity

  • Limited liability for debts

Cons

  • Complex tax-filing

  • Limited capital appreciation

  • Limited to a few sectors

## Instances of MLPs

As of now, most MLPs operate in the energy industry. An energy master limited partnership (EMLP) commonly gives and oversees resources to other energy-based businesses. Models could incorporate firms that give pipeline transportation, refinery services, and supply and logistics support services for oil companies.

Many oil and gas firms will put together MLPs as opposed to giving shares of stock. Utilizing the MLP structure, the two of them can raise capital from investors and keep a stake in operations.

A few corporations might possess a sizable interest in their MLPs. They may likewise set up separate stock-giving companies whose job is to claim units of the corporation's MLP. This structure allows them to rearrange the passive income through the corporation as normal dividends.

Linn Energy Inc.

An illustration of this structure was Linn Energy Inc., which had both a MLP (LINE) and a corporation that owned an interest in the MLP (LNCO). Investors had the option to pick โ€” for tax purposes โ€” how they might want to receive the income the company generated.

The firm was broken down in 2017 in the wake of filing for bankruptcy in 2016. It was reorganized in 2018 as two new companies: Riviera Resources and Roan Resources. Investors in LINE were given an exchange offer to change over their units into shares of the new elements.

As numerous MLPs operate in the resources sector, their fortunes are determined by unstable energy and commodities prices (as confirmed by Linn Energy's bankruptcy).

The Alerian MLP Index, the leading check of energy infrastructure MLPs, estimated an annualized price of 0.7% in the five-year period ended March 31, 2021. Power prices were in a slight upward trend over the majority of that period. Nonetheless, with crude oil prices bouncing back roughly 35% from Feb. 2021 to Jan. 2002, the Alerian MLP Index flooded 46% over that period.

An investor interested in buying MLPs could consider investing in a portfolio of MLPs that is diversified across sectors to reduce risk.

For instance, Brookfield Asset Management, a leading global alternative asset manager with more than $700 billion of assets under management, has MLPs in the real estate, infrastructure, and renewable energy sectors.

Features

  • MLPs have two types of partners: general partners, who deal with the MLP and administer its operations, and limited partners, who are investors in the MLP.
  • A master limited partnership (MLP) is a company organized as a publicly-traded partnership.
  • MLPs are viewed as low-risk, long-term investments, turning out a slow however consistent revenue stream.
  • Investors receive tax-sheltered distributions from the MLP.
  • MLPs join a private partnership's tax advantages with a stock's liquidity.

FAQ

Does a Master Limited Partnership (MLP) Offer Tax Advantages?

Indeed. For limited partners, they offer a pass-through tax structure. Distributions aren't taxed when received. All things considered, they remain tax-deferred until units are sold. MLP units (up to a certain amount) can pass to heirs tax-free upon the death of the unitholder. Additionally, the tax reform act passed in 2017 allows investors to deduct 20% of their distribution quickly from income (until the expiration of the provision in 2025).

What's a Master Limited Partnership?

A master limited partnership or MLP is a publicly traded limited partnership centered in the real estate or natural resources sector. Investors can buy units of a MLP on national exchanges. MLPs can offer consistent income as well as an assortment of tax advantages. They are not without risk, be that as it may, due to their concentrated exposure to a single industry.

What Are Some Examples of Master Limited Partnerships?

By and large, master limited partnerships are companies that participate in the exploration, development, processing, or transportation of natural resources. They may likewise zero in on real estate. A MLP could claim and operate oil and gas pipelines. Or then again, it could zero in on investigating for and delivering crude oil. You could likewise track down MLPs that gather and process natural gas.