Master limited partnership closed end funds, commonly known as MLP CEFs, are hybrid MLP companies that operate in the energy sector. Most MLP closed end funds are formed by larger energy companies that seek to restructure their low growth assets by replacing debt with equity.
If you are an income-oriented value investor, MLP CEFs are an attractive investment as they combine a high yield, high distributions, and a tax-deferred income. In addition, if you keep your MLP CEF in a qualified retirement account and you invest in multiple MLP funds, you get the investment exposure you want, and you avoid the K-1 tax hassle.
The tax advantage of the MLP CEFs
In fact, the MLP closed end funds combine the advantages of corporations and partnerships because they issue publicly traded equity interests (units) but pay taxes as limited partnerships. To better understand the tax advantage, consider that most equity funds are RICs (regulated investment companies), which allows them to pass the capital gain taxes and income to investors and avoid taxation.
However, RICs cannot invest more than 25% of the portfolio in MLPs. Therefore, most MLPs are organized as C-corporations to invest exclusively in MLP closed end funds and pay the 35% corporate income tax.
The tax advantage of the MLP CEFs is effective if they earn at least 90% of their income from oil and gas products as well as natural resources that pertain to the section 613 of the federal tax code. So, if you are seeking exposure to the energy sector along with a tax-deferred income, MLP closed end funds can be worth considering. [click to continue…]