Master Limited Partnership MLP Definition

Liz Manning has researched, written, and edited trading, investing, and personal finance content for years, following her time working in institutional sales, commercial banking, retail investing, hedging strategies, futures, and day trading.

A master limited partnership (MLP) is a publicly traded limited partnership that combines the tax benefits of a private partnership with the liquidity of a publicly traded company.

MLPs generally experience cash flow stability and are required by the partnership agreement to distribute a set amount of cash to investors. Their structure can help reduce the cost of capital in capital-intensive businesses, such as the energy sector.

The first MLP was organized in 1981; however, by 1987, Congress limited the use of them to the real estate and natural resources sectors to prevent too much lost corporate tax revenue. MLPs do not pay federal income taxes.

Key Takeaways:

– A master limited partnership (MLP) is a publicly traded partnership that combines the tax advantages of a private partnership with the liquidity of a publicly traded company.

– MLPs have two types of partners: general partners who manage the MLP and oversee its operations, and limited partners who are investors in the MLP.

– MLPs provide tax-sheltered distributions to investors.

– MLPs are considered low-risk, long-term investments that offer a steady income stream.

Understanding Master Limited Partnerships (MLPs):

– MLPs are a hybrid legal entity that combines elements of a partnership and a corporation.

– MLPs issue units instead of shares, which are traded on national stock exchanges.

– Limited partners are investors who purchase shares in the MLP and receive periodic distributions.

– General partners are responsible for managing the day-to-day operations of the MLP.

Tax Treatment of MLPs:

– MLPs are treated as limited partnerships for tax purposes, with profits and losses passed through to the limited partners.

– Deductions, such as depreciation and depletion, also pass through to limited partners.

– MLPs must generate at least 90% of their income from qualifying activities to maintain their pass-through status.

– Quarterly distributions from MLPs are treated as return of capital and remain tax-deferred until unitholders sell their interests.

– MLPs are not subject to double taxation like corporations.

Advantages and Disadvantages of MLPs:

Advantages:

– MLPs offer slow yet steady investment returns, particularly in slow-growing industries.

– Cash distributions from MLPs usually grow slightly faster than inflation and are often tax-deferred.

– Limited partners’ liability for an MLP’s debts and obligations is limited to their capital contribution.

– Investors can deduct a portion of their distributions from taxable income.

– MLPs can be used for estate planning, with tax benefits during transfer.

Disadvantages:

– Complex tax-filing requirements for MLPs, including IRS Schedule K-1 forms.

– State income taxes may apply in each state where an MLP operates.

– Net losses cannot offset other income, but can be carried forward.

– Limited upside potential for MLPs due to their focus on steady income.

Examples of MLPs:

– Most MLPs operate in the energy industry, providing services such as pipeline transportation and refinery services.

– Oil and gas firms often organize MLPs to raise capital and maintain a stake in operations.

– Some MLPs are owned by corporations, allowing the redistribution of passive income through regular dividends.

In summary, a master limited partnership (MLP) is a publicly traded limited partnership that combines the tax benefits of a private partnership with the liquidity of a publicly traded company. MLPs offer steady income, tax advantages, and limited liability for investors. However, they also have complex tax-filing requirements and limited upside potential. Most MLPs operate in the energy sector, and investors can consider a diversified portfolio of MLPs to mitigate risk.