by Dividend Growth Investor | July 22, 2013 4:25 am
I recently sold two-thirds of my position in Enterprise Product Partners (EPD). I laid out all the facts behind the sale in the original article. However, several readers missed the facts, and instead utilized their opinions and their own experiences in order to negate the article.
Now I never pay attention to other people’s mere opinions, because I firmly believe that comments on my investing strategy do not really add much to my investment performance results. This is a crude paraphrase of Warren Buffett’s famous quote that “You Pay a High Price for Cheery Consensus” ( I am no Buffett though). However, when I am presented with facts, rather than opinions, I always listen.
I typically try to hold securities” forever”, although I tend to avoid holding too tight if I can find a better play(s) that is of similar quality, yet can provide me with more bang for my buck. Kinder Morgan Inc (KMI), Kinder Morgan Management LLC (KMR) and Oneok Partners (OKS) fit the profile.
If other comparable MLPs were trading similarly to Enterprise Product I would have been more than happy to hold. I am also trying to maintain flexibility as well, just in case. Dividend investing is not a black or white activity, which is why rigid rules based systems never really hold up in real life.
Many of the arguments against my selling related to the “onerous tax” picture of selling. I often have mentioned that I never care about taxation when I sell. More investment sins are probably committed by otherwise quite intelligent people, because of “tax considerations” than from any other cause. Anyone that puts taxes before investment quality is just asking for trouble. I have known of many investors who never sold their employer stock at a gain, in order to avoid paying taxes. Well, lucky for most of them, the gains had turned into losses by the time they needed the money to put a down payment on a house, send a kid to college or retire from the workforce. So much for putting taxes before your investment thesis.
However, as investing is more of a gray area than black or white, I am also open to a more softer approach to tax management. For example, this year I began maxing out my 401 (k). I also maxed out SEP IRA for 2012 right around April 15, 2013.
Because I am still in the accumulation phase of building my nest egg, I have come to realize that taxable MLP’s with their K-1 forms might not be the most optimal investment from a tax standpoint for me right now. This is because I don’t really plan on using this money to live off for several years from now. As a result, I might be better off in an entity like Kinder Morgan Management LLC than a Kinder Morgan Energy Partners. It doesn’t make sense to be collecting distribution income today from an MLP, when this reduces taxable base and my retirement is years from now.
Several individuals reaching out to me about the post, had mentioned that they had purchased Enterprise Product Partners at prices such as $20 to $30 per unit. Because they had held the partnership for so long, their basis was probably approaching zero. As a result, they viewed my selling of Enterprise Product as a bad idea.
However, they thought of it as a bad idea, because they didn’t read the facts of the article, that was pertaining to my situation. Instead they chose to be viewing it from their own position. Ignoring facts is typical in most aspects of life, as humans are emotional creatures that respond better to emotion that factual evidence. Ignoring the facts is what separates winning investors from losing one.
Basis in master limited partnerships can keep dropping over time, because depreciation typically is higher than income, and therefore the net result is a distribution that is classified as return of capital by the tax authorities. As a result, this distribution decreases your tax basis. This means that as long as your basis is above zero, any distributions you receive from an MLP would not be taxed.
If you decide to sell however, your tax situation is very interesting. If you bought at $40 per unit in 2011, and sold at $63.73 per unit in 2013 your gain is more than the $23.73 difference. This is because you likely earned about $6.27 per unit in distributions during that period ( approximations are made in this example in order to end up with nice rounded numbers that are easier to digest). As a result, you owe about $30 per unit to tax authorities. $6.27 of this would be taxed as ordinary income, while $23.73 would be taxed as a long-term capital gain.
If your head is spinning from these numbers, you are not alone. You see, the biggest reason investors have against selling Enterprise Product is because of taxes. With a basis of about $40 something per unit, and gain of about $20 capital and $6 to $7 return of capital, I am doing the smart thing of cutting my “stake” early, and moving into other entities that can provide me with slightly better growth, yield and total returns, minus the tax nightmares. It is just intriguing to me that some investors are preaching against selling because the taxes were onerous, yet they did not register the flaw in their thinking.
It therefore seems smarter to sell Enterprise Product when I have a $6 to $7 ordinary gain and buy a security with slightly better characteristics (KMI and KMR) and pay the least amount of taxes, than do this in 10 – 15 years, when my basis will be zero. After your basis is exhausted, and you don’t add any more funds, you will have to pay ordinary income taxes on the amount you receive as distributions.
I am still holding onto approximately 33-34% of original position in Enterprise Product Partners (EPD). The partnership could easily end up yielding less than 4%, which could be a sell signal. If the partnership yields less than 4% however, I might consider dropping my stake altogether. I also am going to keep my options open, and could decide to sell by end of 2013 and replace it with Kinder Morgan Management LLC for example.
Astute readers would notice that for my original position of Enterprise Product I am left with about 50-55% in MLP entities for this position (EPD and OKS). They are subject to these onerous MLP K-1 filings that so many other investors are losing sleepless nights over. Of course, as I mentioned before, the decision to sell was based on valuation, although taxes did come out second in the decision.
I found the Enterprise Product partnership to be richly valued, and I liked the fact that there are alternatives that can provide me with better values. In addition, because of adding to Kinder Morgan Inc and Kinder Morgan Management LLC I am going to have less of a hassle with MLP filings. Kinder Morgan Inc is going to deliver higher dividend growth, and possibly high total returns – at 4% yield growing 10% is much better than a 4.30% yield growing 6%. Kinder Morgan Inc is a corporation, and therefore I am dealing with 1099 at tax time, versus K-1s.
Kinder Morgan Management LLC is a better choice than Enterprise Product because it pays distributions in extra stock, which is not a taxable event. It also yields moreand would likely have slightly higher distributions growth. In addition KMR trades at a discount to Kinder Morgan Energy Partners which is closely tracks ( although not as high as a few years ago). So no K-1 forms here either.
ONEOK Partners is more of a value play here, as it is not loved by investors at present times. However, if the partnership growth plans materialize, you could be very positively surprised in 4-5 years. Sure, there are K-1s there, but I believe it will do much better than EPD over time.
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