Energy master limited partnerships (MLPs) are an option to expand and diversify your portfolio. With 2008 spike in oil and gas prices, this investment vehicle became more popular..
AOG Wealth Management, a wealth management firm located in the Metro DC area, can help you understand MLPs and if they are a good investment for your particular situation.
The Benefits of an MLP
An MLP is a unique type of investment that combines the liquidity of a regular stock and the tax benefits of a limited partnership. Although it follows the structure of a partnership, investors receive investment units that firms trade on an exchange similar to common stock.
One of the reasons many individuals choose an MLP is its tax advantage. As a limited partnership, it doesn’t have tax on the company level. Furthermore, it doesn’t suffer from double taxation on dividends, which helps companies reduce their cost of capital effectively. The tax liability is then passed on to the investors or unitholders. Each year, investors receive a K-1 statement with information about the MLP’s net income, which will be taxed at your individual rate.
Although its income is passed to its unitholders for taxation purposes, the actual distributions of cash have little to do with the company’s income. Firms use a distributable cash flow (DCF) to determine cash distributions. Unlike regular stock dividends, cash distributions aren’t taxed when you receive them. They are treated as reductions in the cost basis of the investment. This results in a tax liability, which is withheld until the MLP is sold.
Unlike other types of investments, MLPs have a greater DCF than taxable income, which leads to significant tax deductions and depreciation. Therefore, investors receive higher cash payments than taxable income. According to research, unitholders only shoulder about 10% to 20% of the MLP’s taxable income. The rest is considered as return of capital and will be deducted from the initial investment’s original cost basis.
Although many investors are fine with deferred taxation, others don’t like being taxed at marginal rates. Some investors use MLPs for estate planning, deferring the recapture. With this method, you benefit from a tax-deferred income stream while avoiding a huge tax hit later.
Oil and gas MLPs can be appropriate investments for the right person. As with other types of investments, you must make sure that you understand the investment product. AOG Wealth Management in Washington, DC, can provide you with information on this investment strategy. Contact us to schedule a complimentary consultation to learn more about MLPs.