When it comes to energy investing, it's tough to beat the returns of a Master Limited Partnership (MLP).
MLPs are publicly traded on a securities exchange and, under federal law, can only be formed for certain businesses, mostly for those involved with natural resources.
To qualify for MLP status, a partnership has to generate at least 90% of its income from "qualifying sources" - usually activities related to the production, processing, or transportation of natural gas, coal, and oil.
Our own Money Morning Global Energy Strategist Dr. Kent Moors considers MLPs one of the best ways to invest in the energy sector.
"Midstream MLPs have long been one of my favorite investments - and a very successful part of my energy portfolio for subscribers," Moors wrote earlier this month.
And for good reason - here's why MLPs are a profitable tool for energy investing...
These Advantages Make MLPs An Energy Investing Favorite
This form of energy investing offers very high returns to investors as compared to bonds and dividend stocks. That's because MLPs' cash distribution is relatively steady and less affected by various harsh economic factors such as inflation.
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As a result, an increase in interest rates can mean significant gains in unit share value. And an MLP's stability means they are better able to maintain a uniform cash flow over the years. In fact, investors are able to predict cash distributions of MLP units in advance.
Additionally, MLPs are a profitable energy investing choice because they combine the tax benefits of a limited partnership with the liquidity of a publicly traded security.
Most companies that qualify for MLP status do opt in, in order to reduce their tax expenses.
You see, shareholders in a corporation have to withstand double taxation - that is, they are taxed at the corporate and at personal level immediately they receive their earnings/dividends from shares. On the other hand, investors in a partnership are only taxed once after receiving their distributions. Since MLPs are classified as partnerships, they avoid corporate income tax at both state and federal levels.
If cash distributions exceed the partnership income, the difference between the two is usually redirected to the limited partner as capital gain, which is taxed. Nevertheless, the capital tax rates are usually lower than the income tax rates. Also, the amount is only taxed when the unit holder decides to sell his or her units.
"From their tax advantages to their high-paying yields, it's hard to beat the returns of a Master Limited Partnership - especially in the midstream segment," Moors wrote.
Due to the absence of a corporate income tax, MLPs are typically able to take advantage of capital more so than other corporations and businesses. This in turn enables them to pursue costly projects that other taxable companies may not be able to carry out due to the high cost and tax constraints.
And finally, another perk of using MLPs for energy investing is that general partners are paid using sliding scale criteria - their share value increases as the cash flow from limited partner distribution increases. That means the general partners are incentivized to increase their limited partnership distributions because doing so increases their ownership percentage.
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