7775 / What are some of the potential advantages of investing in a master limited partnership (MLP)?
As discussed in Q 7768, a primary advantage of the MLP structure is that it avoids double taxation through its characterization as a pass-through entity. Additionally, many investors are attracted to MLP investments because of this type of security’s typically high returns. MLPs entice investors by contractually agreeing to distribute all available cash on a quarterly basis, although the general partner may have the discretion to hold reserves in order to carry on the operations of the business.1
Equally beneficial for investors is the fact that most partnership agreements create a subordination period provision, which usually places the sponsor’s limited partnership interest on hold. Effectively, this provision allows for sufficient cash flow to be distributed so that common units receive minimum distribution levels.2
It is also important to note that distributions issued to limited partners are tax-deferred as these distributions are treated as a return of capital. The distributions act to reduce a limited partner’s basis to the point of that partner’s cost basis.3 Once that basis reaches zero, any subsequent distribution is then taxed at current tax rates.4