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I have written about Real Estate Investment Trusts (REITs) and Canadian Oil Royalty Trusts.  Today I would like to cover another tax advantaged investment called Master Limited Partnerships (MLPs). 

Because of their partnership structure, if MLPs meet certain tests they pay no taxes on their income.  This avoids the double taxation which occurs when a company pays taxes, pays a dividend and the share holder has to pay taxes again on the dividend.

MLPs are structured with a General Partner (GP) which generally owns 2% of the units (like shares) and many Limited Partners (LPs) who own the rest of the 98% of the units. The GPs make all the decisions, raise money and run the company.  The LPs provide capital and have little or no say in company decisions.  The units are freely traded on stock exchanges and don't have minimum holding periods.

MLPs have to distribute 90% of their income from qualifying sources.  These distributions go to unit holders proportionally to their holdings except that the GP can receive incentive distributions for meeting certain growth and income targets.
MLPs also allocate depreciation, amortization and other deductions on a pro-rata basis to the partners.  This results in a tax shield of around 80% to 90% of their distributed income each year.  The deferred taxes are paid when the partner sells.  The MLP tracks all of this and sends you a K-1 form with all of the details for filing your taxes.

There is one HUGE warning.  There is a section of the IRS code dealing with Unrelated Business Taxable Income (UBTI).  If you put MLPs into an IRA or other tax advantaged account and the MLPs pay you more than $1,000, you will owe and have to pay taxes on that income EVEN THOUGH IT IS IN THE IRA.

But, businesses being ingenious like they are, MLPs have come up with an alternative structure called I-Units.  In these partnerships, the distributions are in shares instead of in cash.  I-Units do not generate UBTI and do not require you to file a K-1.  If you hold the distributions for at least one year they are treated as long-term capital gains.  But, you give up current income.  If you want to hold MLPs in an IRA I-units might work for you.

Also, because MLPs distribute income like the coupons on bonds, they are sensitive to changes in interest rates.  If interest rates are going up the value of your units will fall somewhat.

Most MLPs today are in midstream energy businesses like pipelines, storage tank farms, and processors of oil, natural gas, and refined petroleum products.  As such they are attractive targets for terrorists. 

If you are an investor looking for current income and modest but reliable growth, you may wish to investigate MLPs further.