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Master limited partnerships (MLPs) are limited partnerships publicly traded on a stock exchange. For a company to qualify as an MLP, it must generate about 90% of its revenue from real estate, commodities, or natural resources.
Master limited partnerships have seen immense growth over the last decade. The Alerian MLP index – the sector's benchmark index – reported there were 18 MLP IPOs in 2014. That's a 260% increase from the number of MLP IPOs 10 years before.
They also offer market-beating returns…
MLPs have generated 249% in total returns since April 2005. That surpasses 122% for the S&P 500, 118% for utilities, 117% for REITs, and 59% for bonds.
But before investing in master limited partnerships, it's important to understand how they work and why they're so profitable…
How Master Limited Partnerships Work
But master limited partnerships are different from other energy companies because they have limited exposure to underlying commodity prices. That's because most of them own midstream assets, including utilities, pipeline operators, and underground storage. Midstream operations occur after the exploration and production phase (upstream) and before the refining and distribution phase (downstream).
By transporting, storing, and processing commodities instead of owning them, they can turn a profit as long as the commodities keep flowing.
"When you invest in the midstream, you're far less susceptible to price fluctuations in the underlying commodity, and you are able to collect easy profits from the growing demand in fuels," noted Money Morning Global Energy Strategist Dr. Kent Moors.
Master limited partnerships also offer competitive investment tax benefits…
MLPs benefit from a law dating back to the Reagan era. The law allows them to pay fewer taxes than ordinary stocks. In return, MLPs have to give their profits directly to investors to receive the tax breaks.
They also benefit from a specific loophole providing a tax shield for shareholders.
Master limited partnerships are considered "pass-through entities." They transfer the company's earnings to shareholders without much influence from market behavior.
Nearly 90% of the distribution investors receive comes from depreciation allowances – the cash taken off a company's profit to cover any losses the asset may have experienced during a specific period of time.
What this means is you don't have to pay taxes on nearly 90% of your distribution because it's considered a return by the IRS. For example, if you purchase an MLP for $60 and receive a $6 distribution, $5.40 is tax-deferred. Only the leftover 10% – or $.60 – is taxed as income.
MLPs also offer the best dividend yields on the market.
In fact, several of the 50 stocks on the Alerian Index offer a yield of 7.5% or higher. That beats the Alerian's 6.1% average yield and smashes the Dow Jones' 2.74% average yield.
With those benefits in mind, we picked the best MLP for investors to buy today…