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Master Limited Partnerships, or MLPs, generally refer to publicly traded limited partnerships. As with any type of security, MLPs have their own unique quirks of which an investor should be aware before deciding what role they could potentially have in their portfolio.


Like a stock, an MLP “unit” share is a small piece of ownership of a business. However, whereas stocks are issued by corporations, MLPs can only be issued by businesses which are structured as certain types of partnerships. MLP unit holders become the limited partners of the businesses while the managers are the general partner. A company might want to structure itself as an MLP for several reasons—the primary one being that MLPs as limited partnerships do not pay corporate taxes at either the state or federal levels. However, in order to operate as an MLP, the company must pay out what is called a “quarterly limited distribution,” or QRD, to its limited partners every quarter. MLPs generally cannot get out of paying their QRDs without entering into default as a result.


Because of their mandated quarterly payments, MLPs need to be in stable, high cash flow sectors. Additionally, many MLPs are required to generate 90% of their income from “qualified sources,” which usually refers to energy infrastructure.


Similarly to REITs, many income investors like MLPs because their tax-efficient structure allows them to pay out on higher yields than common stocks which have to pay taxes prior to distributing dividends. Further, much of the quarterly distribution may able to be netted against depreciation or may be considered return of capital for tax purposes, meaning that when the unit holder receives QRDs, he can adjust down his cost basis on the units and defer his taxes. Because of the structural differences, the tax form associated with MLPs is not the typically known “1099,” but rather the “K-1,” which takes into account income amounts and depreciation. Depreciation is used as a tax shield, charged against income, since most MLPs tend to receive large depreciation amounts due to their assets (natural gas and oil pipelines, for example).


While there are clear advantages to MLPs, there are some issues which arise when investing in this asset class. Correctly representing depreciation on tax forms can be a difficult and complex task for individuals without qualified tax accountants. Additionally, individuals should be careful that their investments do not cause them to be subject to unrelated business income taxes (UBITs) which can arise in certain cases when owning MLP units. This can also be an issue in gifting. Furthermore, if your cost basis is ever adjusted down to zero, all your distributions become taxable.


Of course, as is the case with any investment tool, there are risks or downsides to investing in MLPs. From a regulatory standpoint, should the government ever decide to change the tax breaks to MLPs, they would lose a large part of their appeal.