Master Limited Partnerships


H

HW \Skip\ Weldon

I am beginning to see more and more of these being offered to
investors and would like to see some of your thoughts on MLPs.

Three things that hit me:

1. Like other investments that offer current tax reduction, what
actually happens depends on what Congress does in their search for
more revenue. I recall the LPs of the early-80s, and how they got
their legs cut out from beneath them by tax changes. Owners couldn't
give 'em away.

2. Lack of diversification. Most of the ones I am seeing are focused
on energy-type investments.

3. Costs. Like their predecessors of the 80's, there are plenty of
hands in the pie.

Comments or observations?

-HW "Skip" Weldon
Columbia, SC
 
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W

Wallace

HW "Skip" Weldon said:
I am beginning to see more and more of these being offered to
investors and would like to see some of your thoughts on MLPs.

Three things that hit me:

1. Like other investments that offer current tax reduction, what
actually happens depends on what Congress does in their search for
more revenue. I recall the LPs of the early-80s, and how they got
their legs cut out from beneath them by tax changes. Owners couldn't
give 'em away.

2. Lack of diversification. Most of the ones I am seeing are focused
on energy-type investments.

3. Costs. Like their predecessors of the 80's, there are plenty of
hands in the pie.
Skip, please refresh my memories on the tax changes to the LPs a couple
decades ago. thanks.
 
M

Mike Morgan

Skip, please refresh my memories on the tax changes to the LPs a couple
decades ago. thanks.
I'm not Skip, but here is what happened. In 1986 Congress changed the law
RETROACTIVELY such that non-cash expenses, such as depreciation, could not
be used to create losses that would offset ordinary income. Lots of us bled
from that, and now don't have much confidence in what Congress might do in
the future.

Mike
 
D

Don

I am beginning to see more and more of these being offered to
investors and would like to see some of your thoughts on MLPs.
I don't know about "Master" Limited Partnerships, but have had
unpleasant experiences with ordinary run-of-the-mill Limited
Partnerships. In the area where I live, they are reputed to be good
money makers for the people who organize and sell them, but terrible
investments for the people who buy them. When they are sold, their risk
is underestimated, and the tax advantage is overestimated.

I would say they are definitely not suitable investments for
conservative investors or for seniors seeking higher income in a time
of low interest rates. As for more sophisticated people playing with
money, I don't know.

One point that might be added is illiquidity. If one wants to sell and
move the money invested elsewhere, it is not easy. I think a question
that any investor should ask about any financial product is: "If I want
to sell, how long does it take?" I am not referring to market value
depending on the ups and downs but simply on the time it takes for the
paper work to get processed and the transaction completed. If you can't
get a straight answer to that question, don't buy.
 
W

Wallace

Mike Morgan said:
I'm not Skip, but here is what happened. In 1986 Congress changed the law
RETROACTIVELY such that non-cash expenses, such as depreciation, could not
be used to create losses that would offset ordinary income. Lots of us
bled from that, and now don't have much confidence in what Congress might
do in the future.

ah, yes. But that applied not only to LPs, right?
 
D

Dave

I am beginning to see more and more of these being offered to
investors and would like to see some of your thoughts on MLPs.

Comments or observations?
Limited partnerships start with a general partner with experience and
limited partners with money.

They end when the general partner has the money and the limited
partners have the experience.

Dave
 
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H

HW \Skip\ Weldon

In 1986 Congress changed the law
RETROACTIVELY such that non-cash expenses, such as depreciation, could not
be used to create losses that would offset ordinary income. Lots of us bled
from that, and now don't have much confidence in what Congress might do in
the future.
One of the best teachers is experience. Unfortunately, it also is one
of the most expensive teachers.
 
T

Tad Borek

HW said:
I am beginning to see more and more of these being offered to
investors and would like to see some of your thoughts on MLPs.
Skip, my thoughts...

1. they do complicate your taxes, if held in a taxable account. Most
people aren't used to dealing with a K-1 and tax software might not deal
with the nuances. If you pay for tax prep, it's an additional cost. And
there can be state income tax returns for MLPs operating in multiple
states, as many do. You have to decide where to file, and understand the
effects on your home-state tax return.

2. holding in IRAs can be a solution but you need to understand UBTI and
know whether your specific MLP is going to cause problems.

3. I'm skeptical of newer issues because the tax aspects are hard to
assess without a track record to look at. For other reasons too but
that's a very practical one.

4. they seem to be incredibly illiquid at times, which (if temporary) is
good if you want to buy and bad if you need to sell. And liquidity is an
issue generally - low trading volume per day is common - which favors
long-term holds and patient buying.

5. tax changes might not have a huge effect. My sense is people are
often weighing these vs. income generating securities like corporate
bonds, preferreds, REITs - which are all or part ordinary income anyway.

6. I personally think the more boring the business, the better. There
isn't necessarily a tight relationship between MLP profit and energy
prices...the core business might be charging tolls to get a product from
point A to B with only slight variations in volume year to year.

-Tad
 
D

Don

6. I personally think the more boring the business, the better. There
isn't necessarily a tight relationship between MLP profit and energy
prices...the core business might be charging tolls to get a product
from point A to B with only slight variations in volume year to year.
Anyone buying any financial product that delivers high interest based
on flow-through of profit from a company directly to investors, needs
to thoroiughly understand the concept of RETURN OF CAPITAL. The
attractive interest rate may be misleading, especially at the time you
want to sell. The tax advantages may be similarly misleading when
return of capital is taken into consideration. If you do not understand
the concept of return of capital and are comfortable with it, do not
invest in a limited partnership, a master limited partnership,
flow-through trusts, royalty trusts, or similar products, by whatever
name they may be known!
 
T

Tad Borek

Don said:
Anyone buying any financial product that delivers high interest based on
flow-through of profit from a company directly to investors, needs to
thoroiughly understand the concept of RETURN OF CAPITAL. The attractive
interest rate may be misleading, especially at the time you want to
sell. The tax advantages may be similarly misleading when return of
capital is taken into consideration.
That's a good point. The life cycle of owning an MLP starts with
largely/completely tax-free distributions, until you use up all your
cost basis. Then, you're taxed on distributions at the capital gains
rate. If you sell, any gain that results from the adjustments to basis
is taxed as ordinary income, even if you've held the MLP units more than
a year. This is a simplification but that's the basic idea.

This tax profile favors (for example) someone in a higher tax bracket
who wants income now, and either would hold "forever" or wouldn't mind a
big ordinary-income item on their tax return many years from now when
they sell units to raise cash. That implies that they expect a lower tax
bracket in the future, than they have now.

Or, keep the position small enough that UBTI isn't an issue, hold in an
IRA, and forget about the K-1 and basis problems.

-Tad
 
D

Don

This tax profile favors (for example) someone in a higher tax bracket
who wants income now, and either would hold "forever" or wouldn't mind
a big ordinary-income item on their tax return many years from now when
they sell units to raise cash. That implies that they expect a lower
tax bracket in the future, than they have now.

Or, keep the position small enough that UBTI isn't an issue, hold in an
IRA, and forget about the K-1 and basis problems.
Yes! And there also depletion of one's equity in the venture as
"capital is returned." That tends to lessen the value of the investment
in the future if one wants to sell.
 
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D

Don

I am beginning to see more and more of these being offered to
investors and would like to see some of your thoughts on MLPs.

Comments or observations?
Along these lines, here is another question that might be interesting
to ponder: Would a son or daughter expecting a large inheritance be
pleased to learn that his or her aging parents had put a substantial
part of their wealth into a Master Limited Partnership in order to
increase monthly income in their old age?
 
T

Tad Borek

Don said:
Along these lines, here is another question that might be interesting to
ponder: Would a son or daughter expecting a large inheritance be pleased
to learn that his or her aging parents had put a substantial part of
their wealth into a Master Limited Partnership in order to increase
monthly income in their old age?
Quite possibly, yes - in fact that could be an ideal case. The initial
distributions are tax-free return of capital. After basis reaches $0,
subsequent distributions are taxed at the capital gains rate (which
might be 0% federal). So the parents get investment income at low/0 tax
rates. At death, the heirs get basis step-up to fair market value.** The
heirs sell the units and pay no tax.

Now of course if it's an MLP that isn't worth spit after making
distributions, that's no benefit at all. If it's one that has unit
values 2X that of a decade ago, and current basis of $0, much different
story for an heir today. There are big variations, depending in part on
the business the MLP is in.

-Tad

** verify the basis step-up of any specific MLP investment with a tax
pro; this is not specific tax advice
 
D

Don

Quite possibly, yes - in fact that could be an ideal case. The initial
distributions are tax-free return of capital. After basis reaches $0,
subsequent distributions are taxed at the capital gains rate (which
might be 0% federal). So the parents get investment income at low/0 tax
rates. At death, the heirs get basis step-up to fair market value.**
The heirs sell the units and pay no tax.

Now of course if it's an MLP that isn't worth spit after making
distributions, that's no benefit at all. If it's one that has unit
values 2X that of a decade ago, and current basis of $0, much different
story for an heir today. There are big variations, depending in part on
the business the MLP is in.
I am wondering about the extent to which the attractive, tax-dvantaged
case you mention is typical of the bulk of investments in Master
Limited Partneships. I am not aware of details about these products,
but I do know that in the area where I live, so called Royalty Trusts
sometimes gain in value over time, but more often decrease in market
value when they are sold. And the costs and management expenses are
high.

For a senior citizen wanting to leave an inheritance, the degree of
risk is a very important factor. Not many seniors would want to invest
a lot of money in a single high dividend-paying stock, not even if the
company were sound and the past track record were good. So one energy
company of unknown prospects woud not generally be considered a good
idea.

The higher the yield that is advertised, the more one begins to think
of the slogan "If it seems too good to be true ...."
 
T

Tad Borek

Don said:
I am wondering about the extent to which the attractive, tax-dvantaged
case you mention is typical of the bulk of investments in Master Limited
Partneships. I am not aware of details about these products, but I do
know that in the area where I live, so called Royalty Trusts sometimes
gain in value over time, but more often decrease in market value when
they are sold. And the costs and management expenses are high.
Many royalty trusts would not be good candidates for what I described.
Such a trust owns the rights to royalties paid when some commodity is
extracted from the ground. The tax code allows annual depletion
deductions for owners of royalty rights, which then pass through to
royalty-trust unit holders, so distributions received from the trust can
be tax-free. Depletion reflects the reality that the stuff is going to
run out someday - the well will run dry or vein of coal be completely
extracted. Depletion isn't the fiction that depreciation can be - the
eventual value of some streams of royalty income is $0, it's just a
question of when.

That said...some royalties keep going so long that commodity price
increases will make the royalty rights more valuable for many years,
before the well runs dry. And even for short-lived rights, a big
increase in the price of the commodity could make the royalties more
valuable. It's essential to understand how fast the wick is burning, and
the ties to commodity prices, when placing a value on royalties of any
kind (and by extension, trusts owning rights to them).

Energy-transport assets (e.g. pipelines) don't have the same depletion
aspect that natural resource extraction does. They can be more similar
to rental real estate, where you take depreciation while the value is
increasing over time.

But this discussion highlights a key point which is that MLPs (and the
broader term, PTPs - publicly traded partnerships) include a wide range
of businesses and as investments, vary tremendously. Some are complete
garbage! These take work.

-Tad
 
D

Don

On 2009-08-07 13:55:55 -0700 said:
But this discussion highlights a key point which is that MLPs (and the
broader term, PTPs - publicly traded partnerships) include a wide range
of businesses and as investments, vary tremendously. Some are complete
garbage! These take work.
Very interesting. I should think someone considering investing in a
trust, be it royalty or MLP, would be well advised to caefully study
the points you have just made. And also it would seem to me that anyone
going this route should perhaps protect against the risk by investing
in a diversified selection of MLP's, not just one that happens to be
convenient and close at hand for some reason.
 
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B

BreadWithSpam

Don said:
Very interesting. I should think someone considering investing in a
trust, be it royalty or MLP, would be well advised to caefully study
the points you have just made. And also it would seem to me that
Paul Sturm, before he was replaced by Jack Hough, wrote many
times in SmartMoney's StockScreen column about MLPs. The most
recent one I could find was March, 2005:

<http://www.smartmoney.com/investing/stocks/Pipeline-to-Profits-17281/>

Note that the five MLPs he recommends are all (except one)
trading now, after a big up and down move like the rest
of the markets - at around the same price as they were
trading 4+ yrs ago. And have been paying out their yield
(as we discussed here, mostly likely return-of-capital)
all along. (The one exception is up 50% from '05 - though
it peaked at over 100% up from then, about 2yrs ago).

Here: <http://www.google.com/finance?q=ETP+EPD+NRGY+KMR+PAA>

Sturm also talks about some closed-end funds which had
then only recently come out, holding MLPs and taking care
of many of the tax-complicating issues related to holding
them. I haven't spent any time investigating them yet,
but they certainly hold the promise of possibly making
these accessible without much complication.
 

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