Master Limited Partnership (MLP)

What Is a Master Limited Partnership (MLP)?

A master limited partnership (MLP) is a business venture in the form of a publicly-traded limited partnership. It combines the tax benefits of a private partnership with the liquidity of a publicly-traded company.

A master limited partnership trades on national exchanges. MLPs generally experience cash flow stability and are required by the partnership agreement to distribute a set amount of cash to investors. Their structure can also help reduce the cost of capital in capital-intensive businesses, such as the energy sector.

The first MLP was organized in 1981. However, by 1987, Congress effectively limited the use of them to the real estate and natural resources sectors. These limitations were put into place out of a concern over too much lost corporate tax revenue. MLPs do not pay federal income taxes.

Key Takeaways

  • A master limited partnership (MLP) is a company organized as a publicly-traded partnership.
  • MLPs combine a private partnership's tax advantages with a stock's liquidity.
  • MLPs have two types of partners: general partners, who manage the MLP and oversee its operations, and limited partners, who are investors in the MLP.
  • Investors receive tax-sheltered distributions from the MLP.
  • MLPs are considered low-risk, long-term investments, providing a slow but steady income stream.
1:40

Master Limited Partnership (MLP)

Understanding Master Limited Partnerships (MLPs)

The MLP is a hybrid legal entity that combines elements of two business structures—a partnership and a corporation. First of all, it is considered the aggregate of its partners rather than a separate legal entity (as is the case with a corporation).

Second, it technically has no employees. The general partners are responsible for providing all necessary operational services. General partners usually hold an approximate 2% stake in the venture and have the option to increase their ownership.

An MLP issues units instead of shares. However, these units are often traded on national stock exchanges. As a result, they are a liquid security. Traditional partnerships cannot offer the same level of liquidity.

Since an MLP's publicly traded units are not stock shares, those who invest in MLPs are commonly referred to as unitholders, rather than shareholders. Those who buy into an MLP are called limited partners. These unitholders are allocated a share of the MLP's income, deductions, losses, and credits.

MLPs have two classes of partners:

  1. Limited partners are investors who purchase shares in the MLP and provide the capital for the entity's operations. They receive periodic distributions from the MLP, typically every quarter. Limited partners are also known as silent partners.
  2. General partners are the owners who are responsible for managing the day-to-day operations of the MLP. They receive compensation based on the partnership's business performance.

Tax Treatment of MLPs

Pass-Through Tax Consequences

An MLP is treated as a limited partnership for tax purposes, which is a significant tax advantage for investors. A limited partnership has a pass-through, or flow-through, tax structure. This means that all profits and losses are passed through to the limited partners. The MLP itself pays no taxes on its revenues, as most incorporated businesses do. Instead, the limited partners pay income taxes only on their portions of the MLP's earnings.

Further, deductions, such as depreciation and depletion, also pass through to the limited partners. Limited partners can use these deductions to reduce their taxable income.

To maintain its pass-through status, at least 90% of the MLP's income must be qualifying income. Qualifying income includes income realized from the exploration, production, or transportation of natural resources or real estate.

In other words, to qualify as a master limited partnership, a company must generate all but 10% of its revenues from natural resources or real estate activities. This definition of qualifying income reduces the sectors in which MLPs can operate.

Deferred Taxes and the Capital Gains Tax Rate

Quarterly distributions from the MLP are not unlike quarterly stock dividends. However, a portion of a distribution is treated as a return of capital (ROC) as opposed to dividend income. So, the unitholder does not pay income tax on the distribution. Instead, the distribution reduces the cost basis of units.

The distributions remain tax-deferred until unitholders sell their interests in the MLP. Then, the difference between cost basis and sale price is taxed at a combination of the ordinary income tax rate (on the return of capital distribution) and the capital gains tax rate (on the appreciation of the units since purchase). This offers a significant, additional tax benefit.

MLPs are taxed as partnerships not corporations. So their profits are not subject to the double taxation that corporations face. Corporations pay corporate tax and then the shareholders must pay personal taxes on the income from their holdings.

Advantages and Disadvantages of MLPs

Like any investment, MLPs have their pros and cons. MLPs may not work for all investors. An investor must weigh the disadvantages against the benefits of holding units of MLPs before they invest.

Advantages

  1. MLPs are known for offering slow yet steady investment returns. The slow returns stem from the fact that MLPs are often in slow-growing industries, like pipeline construction. This slow and steady growth means MLPs are low risk. They earn a stable income often based on long-term service contracts. MLPs offer steady cash flows and consistent cash distributions.
  2. The cash distributions of MLPs usually grow slightly faster than inflation. For limited partners, 80% to 90% of the distributions are often tax-deferred. Overall, this lets MLPs offer attractive income yields—often substantially higher than the average dividend yield of equities. Also, with the flow-through entity status (and the absence of double taxation), more capital is available for future projects. The availability of capital keeps the MLP competitive in its industry. 
  3. Further, for the limited partner, cumulative cash distributions could exceed the portion taxed at the capital gains rate once units are sold.
  4. Limited partners' liability for an MLP's debts and obligations is limited to the amount of their capital contribution.
  5. Until the 2017 tax cuts act benefit expires in 2025, investors can deduct 20% of their distributions from their taxable income, reducing the tax they would otherwise pay.
  6. There are benefits to using MLPs for estate planning, as well. When unitholders gift or transfer the MLP units to beneficiaries, both unitholders and beneficiaries avoid paying taxes during the time of transfer. The cost basis will readjust based on the market price during the time of the transfer if the transfer happens because of death. There is no step-up in basis if the MLP's units are gifted. Should the unitholder die and the investment pass to heirs, the units pass tax free and fair market value is determined to be the value as of the date of death.

Disadvantages

  1. MLPs are extremely tax-efficient for investors. However, the filing requirements for this business structure are complex. An MLP’s income, deductions, credits, and other items are detailed each year on an Internal Revenue Service (IRS) Schedule K-1 form that is sent to the investor. The K-1 can be complicated and create extra work for investors (or the tax professionals they hire).
  2. MLP investors are required to pay state income taxes on their allocated portion of income in each state in which the MLP operates (which can be more than one). This can increase their costs.
  3. Another tax-related disadvantage of MLPs is that you cannot use a net loss (more losses than profits) to offset other income. However, net losses may carry forward to the following year. When you eventually sell all of your units, a net loss can then be used as a deduction against other income.
  4. MLPs have limited upside potential. However, this might be expected from an investment that should produce a gradual yet reliable income stream over several years.
Pros
  • Steady income

  • Relatively low risk

  • Tax-advantaged treatment

  • Liquidity

  • Limited liability for debts

Cons
  • Complex tax-filing

  • Limited capital appreciation

  • Limited to a few sectors

Examples of MLPs

Currently, most MLPs operate in the energy industry. An energy master limited partnership (EMLP) typically provides and manages resources for other energy-based businesses. Examples might include firms that provide pipeline transportation, refinery services, and supply and logistics support services for oil companies.

Many oil and gas firms will organize MLPs instead of issuing shares of stock. Using the MLP structure, they can both raise capital from investors and maintain a stake in operations.

Some corporations may own a sizable interest in their MLPs. They may also set up separate stock-issuing companies whose role is to own units of the corporation's MLP. This structure allows them to redistribute the passive income through the corporation as regular dividends.

Linn Energy Inc.

An example of this structure was Linn Energy Inc., which had both an MLP (LINE) and a corporation that owned an interest in the MLP (LNCO). Investors had the option to choose—for tax purposes—how they would like to receive the income the company generated.

The firm was dissolved in 2017 after filing for bankruptcy in 2016. It was reorganized in 2018 as two new companies: Riviera Resources and Roan Resources. Investors in LINE were given an exchange offer to convert their units into shares of the new entities.

As many MLPs operate in the resources sector, their fortunes are determined by volatile energy and commodities prices (as evidenced by Linn Energy's bankruptcy).

The Alerian MLP Index, the leading gauge of energy infrastructure MLPs, measured an annualized price of 0.7% in the five-year period ended March 31, 2021. Electricity prices were in a slight upward trend over most of that period. However, with crude oil prices rebounding approximately 35% from Feb. 2021 to Jan. 2002, the Alerian MLP Index surged 46% over that period.

An investor interested in buying MLPs could consider investing in a portfolio of MLPs that is diversified across sectors in order to reduce risk.

For example, Brookfield Asset Management, a leading global alternative asset manager with over $700 billion of assets under management, has MLPs in the real estate, infrastructure, and renewable energy sectors.

What's a Master Limited Partnership?

A master limited partnership or MLP is a publicly traded limited partnership focused in the real estate or natural resources sector. Investors can buy units of an MLP on national exchanges. MLPs can offer steady income as well as a variety of tax advantages. They are not without risk, however, due to their concentrated exposure to a single industry.

Does a Master Limited Partnership (MLP) Offer Tax Advantages?

Yes. For limited partners, they offer a pass-through tax structure. Distributions aren't taxed when received. Instead, they remain tax-deferred until units are sold. MLP units (up to a certain amount) can pass to heirs tax-free upon the death of the unitholder. Also, the tax reform act passed in 2017 allows investors to deduct 20% of their distribution immediately from income (until the expiration of the provision in 2025).

What Are Some Examples of Master Limited Partnerships?

In general, master limited partnerships are companies that engage in the exploration, development, processing, or transportation of natural resources. They may also focus on real estate. An MLP could own and operate oil and gas pipelines. Or, it might focus on exploring for and producing crude oil. You could also find MLPs that gather and process natural gas.

Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in our editorial policy.
  1. U.S. Securities and Exchange Commission. "Updated Investor Bulletin: Master Limited Partnerships – An Introduction."

  2. Congressional Research Service. "Master Limited Partnerships: A Policy Option for the Renewable Energy Industry," Pages 5-6.

  3. Congressional Research Service. "Master Limited Partnerships: A Policy Option for the Renewable Energy Industry," Page 5.

  4. Congressional Research Service. "Master Limited Partnerships: A Policy Option for the Renewable Energy Industry," Pages 2-3.

  5. Internal Revenue Service. "Tax Information For Partnerships."

  6. Congressional Research Service. "Master Limited Partnerships: A Policy Option for the Renewable Energy Industry," Pages 1-2, 4.

  7. Congressional Research Service. "Master Limited Partnerships: A Policy Option for the Renewable Energy Industry," Pages 2, 6.

  8. Intelligent Income. "MLP Tax Guide."

  9. Congressional Research Service. "Master Limited Partnerships: A Policy Option for the Renewable Energy Industry," Page 4.

  10. Internal Revenue Service. "Tax Cuts and Jobs Act, Provision 11011 Section 199a - Qualified Business Income Deduction FAQs."

  11. Internal Revenue Service. "Publication 551, Basis of Assets," Pages 9-10.

  12. Internal Revenue Service. "Publication 541, Partnerships," Page 10.

  13. Internal Revenue Service. "Net Operating Losses."

  14. Internal Revenue Service. "Publication 541, Partnerships," Page 5.

  15. LINN Energy. "IRS Form 8937, Report of Organizational Actions Affecting Basis of Security."

  16. LINN Energy. "LINN Energy 2015 Fact Sheet," Page 1.

  17. LINN Energy. "About LINN Energy."

  18. U.S. Energy Information Administration. "Electricity Data Browser," Select "Average Retail Price of Electricity."

  19. VettaFi. "Alerian MLP Index," Download Factsheet, Page 1.

  20. U.S. Energy Information Administration. "Real Petroleum Prices: Short-Term Energy Outlook."

  21. VettaFi. "Alerian MLP Index."

  22. Brookfield Asset Management. "Annual Reports," Download "2021 Annual Report," Page 178.

  23. Brookfield Asset Management. "Home."

Take the Next Step to Invest
×
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.
Service
Name
Description