I've been interested in master limited partnerships since I first discovered them in 2010. I spent a lot of time researching these investments until I was comfortable enough to pull the trigger. Initially my concerns with MLPs were:
#1: I heard they made filing taxes complex
#2: K-1 tax documents are sent late in the tax season
#3: I was afraid I would need to purchase a more expensive version of turbo tax for the K-1s
#4: MLPs are not suitable for ROTH IRAs because of the possibility of owing taxes even in a retirement account.
I decided that in 2011 I would purchase 2 MLPs and find out for myself the answers to these questions. I love MLPs for the high yields, distribution growth, and tax sheltering. Here is my experience.
#1: I heard they made filing taxes complex - I recently did my taxes on Turbo Tax. With my regular dividend stocks I was able to import all the information directly from my broker's website. I didn't have to manually enter anything. With my two MLPs I did have to enter them manually. Supposedly it is possible to import K-1s, I couldn't figure out how to do it. Regardless, I don't understand what the fuss is all about. It took me about 15 mins or so to enter the K-1s, it's not rocket science. I had to google a partnership federal identification number for one of them, but that was it. This concern is overblown. Is it additional work? Yes. Is it hard? No.
#2: K-1 tax documents are sent late in the tax season - I was able to access K-1s on Feb. 27 & 29 respectively for the two MLPs I own. This is mid tax season, other K-1s might come out later I can't say. It would be best to check before purchasing a MLP just in case. I owe Uncle Sam and my state taxes this year. Being unable to file taxes until March is a moot point for me. I wouldn't have done my taxes until now anyways.
#3: I was afraid I would need to purchase a more expensive version of turbo tax for the K-1s - Nope, the version needed for stocks can handle MLPs as well.
#4: MLPs are not suitable for ROTH IRAs because of the possibility of owing taxes even in a retirement account. - Although I do not own MLPs in my ROTH this is true because of the possibility of unrelated business income tax. An MLP must generate 90% of income from "qualified" sources; if it generates too much from unqualified sources UBIT must be paid even in retirement accounts. The investor is safe up to $1000, and from what I've read you would have to own a lot of units for this to trigger.
I do agree that MLPs are not suitable for retirement accounts, but for a different reason. Putting an MLP in a retirement account negates the best feature of the investment. You are able to defer taxes on distributions until you sell the units or until the cost basis reaches zero (distributions reduce your cost basis). It's tax deferment within a taxable account! Why put this in an account that is already tax advantaged? It doesn't make sense. Not at all.
In 2011 I received $1,779.32 of dividend income. $856.85 or 48.2% of this income was either tax free in my ROTH or tax deferred through MLPs. I already pay Uncle Sam enough, he doesn't need more of my money. Being a federal employee it almost feels like I am paying myself, I'll take any tax advantages I can get.
Now that I have a better understand of Master Limited Partnerships I will continue to purchase them. Right now I'm concentrated in natural gas. In the future I'll be looking to add oil and diversified pipelines.