Investing in Master Limited Partnerships: Earn Higher Returns and ...

Master Limited Partnerships Beat the Tax Man

Unlike ordinary stocks, MLPs offer a significant tax shield for investors.

You see, like?real estate?investment trusts, MLPs are pass-through entities that transfer profits and losses to individual unit holders.

But, because of depreciation allowances, 80% ? 90% of the distribution you receive is considered a?return of capitalby the IRS. So you don?t pay taxes immediately on that portion of the distribution.

In other words, 80% ? 90% of the distribution you receive is tax-deferred. The remaining 10% -20% is taxed as regular income.

But here?s the kicker.

You?re not taxed on the return of capital until you sell the units. What?s more, those payments are used to reduce your cost basis on the MLP.

Let?s suppose you purchase an MLP for $50 and receive $5 in distribution payments, $4.50 of which is considered a return of capital. You pay no income tax on that $4.50.

In this case, only the remaining 50 cents is taxed as regular income. Meanwhile, after one year, your cost basis drops to $45.50 ($50 minus $4.50).

Assuming the distribution remains the same the next year, your cost basis would drop again to $41.00. And so on?and so on.

Eventually, your cost basis could go to zero, leaving you with zero tax liability on 80% -90% of your returns.

And if you decide to sell the units sooner, the capital gains are taxed at the more favorable long-term capital gains tax rate-a tremendous benefit, especially for older investors.

MLPs do complicate your tax preparations, so you may find it easier to consult a tax professional. But the additional expense should be well worth it.

Investing in Master Limited Partnerships?

Explosive growth in shale and other unconventional gas production has given MLP investors a wave of new opportunities. That should allow them to continue to expand distributions to investors.

However, the two most popular exchange-traded funds (ETFs) available ? the Alerian MLP ETF (NYSE:?AMLP) and JPMorgan Alerian MLP Index ETN (NYSE:?AMJ) ? pass their profits through as ordinary dividends, so you lose the big tax advantages.

Instead, you?re better off taking a look at one of the following high-yielding MLPs:

Enterprise?Products Partners LP(NYSE:?EPD)?just raised its distribution for the 30th consecutive quarter. Growth in the Rocky Mountains and the Eagle Ford Shale has pushed natural gas production to record levels. Its current yield of 5.26% and steady record of boosting distributions makes it an attractive target for long-term investors.

Linn Energy?(Nasdaq:?LINE)is involved in the actual production of oil and gas and has around 2.8 trillion cubic feet of gas-equivalent reserves, assuring future production growth. Best of all, Linn is fully hedged through the end of 2013 and more than two-thirds hedged through 2014-2015. Whether gas is at $2 or $15, the company should be able to maintain its payout of 8.06%.

Investors should also consider:?Plains All American Pipeline LP?(NYSE:?PAA),?Enduro Royalty Trust?(NYSE:NDRO), and?Magellan Midstream Partners?(NYSE:?MMP).

Either way, investing in master limited partnerships is hard to beat.

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