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Are Master Limited Partnerships Worth the Trouble?

Dan Caplinger
August 21, 2012

Income-hungry investors have turned to a number of previously unknown investments in the search for bigger payouts. In many cases, they've been successful in finding some lucrative opportunities. In the process, though, they've also unearthed some complicated issues to resolve, especially on the tax front.

One of the best examples of this phenomenon is the master limited partnership. MLPs have some very attractive attributes, most notably the huge distribution yields that many of them offer. But those distributions come at a price, and if you don't want to deal with the complications, it'll cost you.

The best of MLPs
It's no secret why MLPs have attracted so much attention. On one hand, the huge amount of energy-related activity in the U.S. has led to a big expansion in the need for the sort of commercial projects that MLPs often take on. For instance, major MLPs Kinder Morgan Energy Partners (NYSE: KMP  ) and Energy Transfer Partners (NYSE: ETP  ) both specialize in midstream energy operations, including pipeline transmission and storage facilities, which have become increasingly important as oil and gas production levels throughout the country have risen.

More importantly from an investor's perspective, these activities produce substantial profit and cash flow, and thanks to special treatment from the IRS, MLPs are able to distribute the lion's share of their income out to investors. That's why Kinder Morgan yields about 6%, while Energy Transfer and Enbridge Energy Partners (NYSE: EEP  ) weigh in at around 7.5% to 8%.

The yields that MLPs pay compare very favorably with those of traditional energy companies. Most of the major integrated oil and gas companies have dividends in the 3% to 5% range. Downstream refining companies often have even lower yields, with HollyFrontier (NYSE: HFC  ) paying just 1.5%, while Valero (NYSE: VLO