An MLP, or master limited partnership, is a publicly traded investment that’s taxed similarly to a limited partnership, but it can be sold and bought. MLP Investments are usually in the energy sector because almost 90% of generated income must come from mining, exploration, extraction, and transportation of alternative fuel sources. Because of the tax structure of an MLP, there are some great benefits to consider. Here, investors can learn why MLPs are taxed the way they are.
An Assembly of Business Owners
An MLP is, as its name implies, a partnership. Investors are treated as business owners rather than in the traditional sense. That means that the MLP’s taxes flow through to the partner or investor. Any losses, income, expenses, or depreciation incurred flows through to the investor. The Internal Revenue Service does not look at all the partners as a whole. It, instead, regards all the partners as individual companies. Investors are responsible for for the taxes on their share of the company’s profits.
Because the IRS treats each of an MLP’s partners as an individual business owner, each person must know his or her cost basis. That way, when the partnership is sold, the IRS can fairly assess capital losses or gains. Add investor’s tax basis can increase under the following circumstances.
The profits are reinvested
The company acquires additional debt
More money is put into the investment
An investor’s tax basis can decrease when the company has a loss, when it pays off debt, or when money is taken out of the investment. It sounds complex to those used to investing in stocks, but it makes sense when one remembers that investors are treated as business partners.
MLPs do not issue dividends. Rather, the check a partner gets may be considered a capital return. When a capital return is received, the investor’s basis goes down, and they don’t have to pay any additional taxes. However, a decreased tax basis may mean that the IRS perceives that the investor has had greater capital gains than they really did.
As one can see here, MLPs come with major tax benefits, but investors should remember that they are still responsible for taxes. The free ride stops when there’s no more capital to return or when the investment is sold. Once a buyer and understands the taxes of the investment, an MLP could be an appropriate option.