Where to Get 6%, With Tax Breaks Master limited partnerships are high-maintenance but worth the hassle, writes Jack Hough.
"A quirky and complex investment class called master limited partnerships has been one of the market's best performers of late. The widely followed Alerian MLP index of 50 energy MLPs returned 14% in 2011, including dividends, versus 2.1% for the Standard & Poor's 500-stock index.
While MLPs can be risky, there is reason to believe they still hold appeal.
MLPs are partnerships that trade like stocks and pass their income directly to investors.
The yields, paid in the form of "distributions" rather than dividends, can be juicy. The Alerian index yields about 6%--triple that of the S&P 500 and about double what investors can get from 10-year, A-rated corporate bonds.
While the income from MLPs is taxable at rates up to 35%, investors often can defer taxes on the bulk of it. That is because MLPs distribute not only cash income but also paper write-offs for their asset depreciation. Investors pay current taxes only on the income that exceeds depreciation. The rest--often 80% or more of the total--serves to reduce the investor's "cost basis," and is taxed only when the investment is sold.
John Edwards, an analyst at investment bank Morgan Keegan, estimates that the amount that MLPs will pay to investors as income will rise 5% to 8% this year. With investors having snapped up many of the larger MLPs last year, he thinks the best opportunities lie in smaller players. Among them: EV Energy Partners (EVEP: 69.59, 1.21, 1.77%), which yields 4.6%; Crosstex Energy (XTEX: 16.66, 0.07, 0.42%), 7.6%; and Genesis Energy (GEL: 28.93, 0.26, 0.91%), 6.3%. He predicts that each of these three will offer double-digit total returns over the next 12 months."