Beginning Freelancers, You Can’t Afford to Pass up This Investment
MLP (Master Limited Partnerships) investing offers some of the best cash return in investing, a huge plus for anyone on an irregular income.
One thing that blogging and freelancing for five years has taught me is that your income can be extremely volatile. It seems to rain cash one month as contracts get paid, only to dry up completely in other months.
Many freelancers turn to passive income investing to fill the gap, looking to smooth monthly income with cash flow from investments. Websites scream out the opportunity to make five- and six-figure income from real estate, stocks and bond investing strategies with little to do but to sit back and collect the checks.
If you’ve been involved in real estate investing as I have, you know that it can be a great source of cash flow but is far from a passive income. Calls to fix broken water pipes come in at all hours and the bookkeeping alone can be a part-time job.
But one investment does offer the opportunity for truly passive income. Better yet, it offers one of the highest cash returns among investments and can help to provide a stable source of cash flow during those anemic months of freelancing.
One of the highest cash returns and a tax break kicker
Master Limited Partnerships (MLPs) are a special type of company established by law in 1981. The companies hold oil & gas investments and escape federal income taxes if they pay out at least 90% of income to investors.
This tax break for the companies is a huge advantage and many of the largest energy corporations have sold their pipelines and storage facilities to MLPs. The energy company gets cash for the sale and pays a fee to use the pipeline or storage tanks. The MLP gets assets with stable demand and ongoing cash flow.
Over the two decades to 2014, MLP investments offered a total return of 15% compared to just 8.6% on stocks and 5.6% on corporate bonds. MLPs offer some of the highest cash return in investing as well. As of year-end 2013, MLPs offered an average cash yield of 5.5% compared to 4.4% for real estate investment trusts (REITs) and just 2% for stocks.
While investor enthusiasm for energy investing has tumbled along with oil prices over the year to August 2015, the revolution in U.S. oil and gas production secures a future for MLPs. These companies book the majority of their revenue from fixed-fees to transport oil and natural gas. That makes sales safer from falling prices and keeps cash flowing into investors’ pockets.
In addition to avoiding corporate income taxes, investors in MLP investments also get a tax break. The MLP passes along the tax benefits from the depreciation of assets to investors which can reduce the taxes they owe each year on the income they collect. As a result, MLP investors generally pay current year taxes only on about 10% to 20% of the income they receive.
Investors pay higher taxes when they sell MLP investments because of the depreciation benefit they took over the years. Another benefit to MLPs is that, if passed through an estate, your heirs will not have to pay any of the taxes owed. The cost of the investment is marked up to the value when they receive it!
This benefit to holding MLP investments forever makes them one of the best passive income investments. Investors don’t feel the need to buy and sell MLP investments constantly, as they do with stocks, so there’s no need to constantly analyze the investment. MLPs produce cash flow immediately with most paying out four times a year, a big plus for those of us living on freelance income.
The one downside to MLP investing is the special form you will receive each year for your taxes. MLPs issue a form K-1 to investors which accounts for all the dividend distributions, capital gains and depreciation passed along during the year. Most do-it-yourself tax software includes a walk-through to add the information to your taxes but some investors find it intimidating. Once you’ve worked through the form the first time, it becomes very easy and the tax benefits to MLP investing are some of the best you’ll find in investments.
Whether you’re looking for a passive income investment to smooth your regular income or just looking for an investment to help meet your long-term goals, MLPs should be high on your list for new investments. Don’t let the extra tax form scare you away from one of the best opportunities in investing and take advantage of a long-term bet on America’s energy revolution.
Joseph Hogue, CFA is an investment analyst and author of The Passive Income Myth: How to Create a Stream of Income from Real Estate, Blogging, Stocks and Bonds. Join the community on PeerFinance101 for more tips on investing, managing debt and reaching your financial goals.