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3 Ways to Invest in MLPs
04/23/2018 5:00 am EST
Since an MLP investment is a partnership stake, the distributions paid by an MLP are classified as return-of-capital. Because an MLP owns depreciable assets, the K-1 from an MLP investment will show little or zero taxable income, explains Tim Plaehn, income expert and editor of The Dividend Hunter.
As a result, investing in MLPs generates non-taxable dividend-like income. One point to remember. While ROC is non-taxable when received, it does reduce your cost basis in the investment. This means the distributions will be recaptured as taxable income when the investments are sold.
Here are three different investments that illustrate different ways, tax-wise, to earn current tax-free, non-destructive, return-of-capital income.
Energy Transfer Partners, LP (ETP) is a $20 billion market cap energy midstream MLP. The company is primarily a natural gas services provider and owns approximately 61,000 miles of natural gas pipeline, 146 Bcf of working storage capacity, and more than 60 natural gas facilities.
For the last two years the ETP unit price has been under pressure for a range of mostly external to the business reasons. Despite the negative investor sentiment, the current quarterly distribution appears secure.
Investors currently earn a 13% ROC yield. ETP is an individual MLP, so an investor receives a K-1 with results to be included on an individual income tax return.
A few MLPs have alternate shares that result in the simpler Form 1099 for investors. Plains GP Holdings, LP (PAGP) is a 1099 reporting partnership. Each PAGP unit is backed by one unit of Plains All American Pipelines LP (PAA)., which is a traditional K-1 reporting MLP.
Plains is the largest crude oil midstream service provider in the Permian Basin. The PAGP units allow investors to receive the same ROC distributions paid on PAA units, but without the Schedule K-1. PAGP currently yields 4.8%.
An MLP owning fund assumes the K-1 tax reporting responsibility and issues Forms 1099 to investors. The ROC distributions paid by the MLPs in a fund’s portfolio pass through to investors as ROC dividends from the fund. An MLP focused fund also provides diversified exposure to the sector, and often other dividend paying energy midstream companies.
Tortoise Energy Infrastructure Corporation (TYG) is an MLP-focused closed-end fund with $1.9 billion in assets. The fund has paid steady, to increasing quarterly dividends since early 2009.
In a fund, the dividends will have a mix of tax characteristics. In 2017 the fund reported all dividends as qualified dividends. The first two payments in 2018 have been classified as ROC. TYG uses about 30% leverage and currently yields 10%.
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