You’ve probably heard the term MLP before, but what exactly is it?
An MLP is a master limited partnership, a business entity commonly used by energy companies as an alternative to a regular corporation.
One of the main advantages of an MLP is that the MLP’s income and losses are not taxed at the MLP level but, instead, are passed through to the investors. From there they are then subject to the normal tax rules.
In short, an MLP is not subject to double taxation like a regular corporation, one of its big pluses. In addition, energy MLP investors buy shares for their generous cash income distributions. Indeed, two big reasons investors like them.
But MLPs aren’t all rainbows and unicorns. Not by a long shot.
The fact is many investors — mostly small retail investors — were sold these investments without being made aware of the potential risks and unintended consequences that I’ve warned repeatedly about over the past 12 to 16 months.
Here’s what I mean …
In the recent past, energy MLP investors were enjoying the good life: Getting handed a juicy cash distribution in a low interest rate world as oil prices soared.
In fact, not only were the cash distributions increasing, but the share price of the MLPs were also heading higher.
That all changed when oil prices started heading south in mid-2014. MLP shares cratered in 2015, losing almost a third of their value on average.
In fact, shares of the Alerian MLP ETF (AMLP) are still down 36 percent since their 2014 peak with some individual MLP shares plunging as much as 99 percent — completely wiping out investors’ wealth.
To make matters worse, those coveted cash distributions that investors had taken for granted have been cut or taken away altogether. And that’s left MLP investors in a world of hurt.
But the bad news doesn’t stop there.
MLPs pass certain tax burdens to their investors. So when debt is forgiven in an MLP restructuring — it can count as noncash income, called “cancellation of debt income.”
Result: A potentially huge tax liability for investors — even if they lost most of the value of their investment. You read that right: Some MLP investors are getting slammed with massive tax bills without collecting a dime in cash. And that’s on top of their MLP investment getting hammered.
Here’s an example: Breitburn Energy Partners shares were trading over $22 back in 2014. Then in May of this year they filed for bankruptcy. The shares got killed … and are now trading at $0.30. Yikes!
But to make matters worse, court documents show Breitburn’s holders could owe taxes of approximately $14 on each unit or share they hold.
So, beware of the unintended consequences — a danger I’m always warning my readers about — of getting sucked in by investments like energy MLPs.
I’ve warned about this for some time. Now, even in MLPs, the piper is being paid. MLPs will rise from the ashes, but not until oil bottoms, which it hasn’t done yet … and not until all the rot has been cleaned up in the MLP bankruptcy cycle.
As tempting as they might be to buy, don’t touch them with a 10-foot pole until I give you the all clear.