Thursday, August 23, 2012

Tax Advantages And Disadvantages Of Investing In Master Limited Partnerships

What's unique about master limited partnerships?

Master Limited Partnerships (MLPs) are absolute in that they embody the tax benefits of a limited partnership with the liquidity of common stock. While a MLP has a partnership arrangement, it also issues tradable units that may be bought and sold on a securities exchange.

Why are not more companies structured as master limited partnerships?

There is a issue why all companies are not master limited partnerships there are strict criteria, as detailed by the Tax Reform Act of 1986 and the Revenue Act of 1987, that restrict which companies may arrangement themselves as MLPs. altogether speaking, a firm must earn 90% of its income through activities or interest and dividend payments relating to natural resources, commodities or real estate to qualify as a MLP.

How is a master limited partnership structured?

A MLP has two kinds of partners - the limited partners (the investors) and the general partner (the managers). limited partner invests capital into the venture and obtains periodic cash distributions, commonly periodical and as a result called required distributions (), the general partner oversees the MLP's operations and receives agitational distributions rights (IDRs). The investors also receive shares of the annual income depending on number of units owned.

What are the tax implications of investing in master limited partnerships?

MLPs, by the awful nature of their arrangement, utilize a number tax advantages. Being a partnership, they keep away from both federal and state corporate taxes. For an individual investor, while the share of the annual income is taxed at the personal tax rate, the periodical distributions are not, but considered as reductions in the investment's cost basis and produce a tax accountability that can be deferred until the security is sold.

Investors frequently get exceeding cash payments than the amount upon which they are taxed, creating an adequate means of tax deferral. As per a 2003 report by Wachovia Securities, the taxable income passed on to investors often is only 10-20% of the cash allotment, while the other 80-90% is deemed a return of capital and departed from the actual cost basis of the endorse investment.

Tax-exempt investment vehicles like pensions, endowments and 401(k) plans are restricted from owning MLPs because the cash distributions received are intended dissimilar business taxable income (UBTI) - income that is unrelated to the activity that gives the fund tax-exempt status. If the annual cash allotment crosses 00, it will be subject to tax. Therefore, when investing in MLPs, invest through a brokerage account and not an IRA account.

How can you calculate the performance of a master limited partnership?

One metric to measure the accomplishment of a MLP is its Cash Flow Coverage Ratio, calculated as follows:

Net Income + Depreciation, Amortization & Other non-cash expenses -
Maintenance Capital Expenditure
Cash Flow Coverage Ratio= ___________________________________________________________
Total Distributions

If this ratio is below 1, the MLP is not generating adequate cash to fund distributions., and should be avoided.

No comments:

Post a Comment