How to Make Sense of Master Limited Partnership Taxes

by Jeff Reeves | January 9, 2012 12:51 pm

Master limited partnerships, or MLPs, are high-yield dividend stocks with a lot of appeal. This class of investment mainly focuses on natural resources, such as petroleum and natural gas.  MLP investments combine the tax advantages of a partnership with high dividends and the liquidity of common stocks.

Some examples of MLP investments include Kinder Morgan Energy Partners LP (NYSE:KMP[1]), Plains All American Pipeline LP (NYSE:PAA[2]) and Boardwalk Pipeline Partners LP (NYSE:BWP[3]) to name a few. As you can see, the LP for “limited partnership” after the name helps tip you off.

However, master limited partnerships do come with their own set of rules — particularly at tax time.

That’s why Don sent in this question:

“If I go on eTRADE and purchase so many shares of an MLP, does that obligate me to remain in the stock for any predetermined length of time? Also, will I automatically get a K-1 form for tax purposes?”

First, the easy answers:

You have no obligation to hold for a set period of time. However, like a dividend stock you will not get paid unless you are a unitholder of the MLP within its disbursement period. Don was particularly interested in Brookfield Infrastructure Partners LP (NYSE:BIP[4]), and that MLP’s last distribution was on Dec. 30. So anyone buying now but bailing out in six weeks later won’t qualify for the next payday.

And frankly, what’s the point of buying an MLP if you don’t get the juicy dividend payout?

For the tax form, yes, unitholders automatically get the K-1 mailed to you — normally in February or March though, not promptly after the turn of the year.

Now for the tough stuff: MLPs each specify a different percentage of their distributions that are shielded from ordinary income taxes. This doesn’t just vary MLP to MLP, but can vary from distribution to distribution within the same company!

You see, a portion of MLP payouts can be tax-deferred, and it is subtracted from one’s cost basis. And when you sell your units, some of the gain that comes from certain deductions (such as depreciation expense) will be taxed as ordinary income.

Hopefully you have a tax man to work through all this for you, because as you can see there are a lot of moving parts.

That said, don’t let this tax complication scare you off of master limited partnerships. They are great income investments even if they are a bit of an oddity.

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Jeff Reeves[5] is the editor of Write him at[6], follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. Jeff Reeves holds a position in Alcoa, but no other publicly traded stocks.

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