| In your search for solid dividend-paying companies, | | | | depreciation of the assets of the business. |
| you will frequently encounter three special kinds of | | | | Taxation of MLPs was established in 1987 by |
| corporations. They have chosen to organize | | | | Congress. The partnership does not pay taxes itself, |
| themselves under federal laws that allow them to | | | | so the distributions sent to unit holders do not qualify |
| avoid corporate taxation provided that they pay out, | | | | for the federal 15 percent cap on dividend income. |
| or distribute, the bulk of their profits to shareholders. | | | | However, not all of the distribution sent each quarter |
| For this reason, these companies appear frequently in | | | | to unit holders is a "dividend." Some of it is a return |
| lists of high-yielding dividend-payers. All three special | | | | of the original capital invested. The returned capital, in |
| forms of companies have ticker symbols, and their | | | | effect, reduces the cost basis of the investment (as |
| stocks trade just as other companies trade. | | | | if the shareholder had spent less per share in the first |
| Here is a primer on these three special corporate | | | | place). Returned capital is not taxed in the year it is |
| forms: | | | | distributed, but it is taxed when the unit holder sells |
| Real Estate Investment Trusts (REITs) | | | | the shares. That is because there will appear to be |
| REITs were created by Congress in 1960. They | | | | more profit on the sale of the shares, since the |
| come in two flavors: Most REITs are essentially | | | | returned capital over the years reduced the cost |
| landlords, holding properties from office parks to | | | | basis. So the returned capital is not, as is sometimes |
| apartments to shopping malls. A far smaller number | | | | stated, non-taxable; rather the taxation is deferred. |
| of REITs are "mortgage REITs," involved in real | | | | When you finally sell those shares, the taxation |
| estate financing. | | | | catches up to the capital returned over time. |
| To qualify as a REIT, a company must distribute at | | | | Because of their unique structure and tax situation, |
| least 90 percent of its taxable income in the form of | | | | MLPs must mail an IRS Schedule K-1 to each unit |
| dividends. Historically, most of the return from REITs | | | | holder every year. This reports the unit holder's share |
| has come from these dividends, although many have | | | | of the partnership's taxable and non-taxable income, |
| delivered attractive price returns to boot. | | | | gain, loss, deduction, and credits. It is really not that |
| REITs are the only practical way for most individuals | | | | difficult to deal with, and any competent tax |
| to invest in residential and commercial real estate | | | | preparer is familiar with K-1's. |
| developments. Real estate is often considered to be | | | | Business Development Companies (BDCs) |
| a distinct asset class (beyond the "big three" of | | | | BDC's were created by Congress in 1980 to help |
| stocks, bonds, and cash), so REITs offer the | | | | provide capital to small businesses. They have been |
| investor some diversification benefits. Current | | | | much in the news lately, usually under the term |
| dividend yields often are 5 to 8 percent or more, | | | | "private equity," as there have been dozens of |
| right out of the gate for new buyers. | | | | recent deals in which companies have been "taken |
| Note, REIT dividends do not qualify for the 15 | | | | private." That means that public companies-some of |
| percent federal income tax rate on most dividends. | | | | them quite large-have been bought in their entirety |
| They are taxed to the shareholder as ordinary | | | | by private equity companies with huge amounts of |
| income. That is because the earnings were not taxed | | | | capital at their disposal. |
| at the corporation's level. | | | | Many of these private equity deals have been made |
| Master Limited Partnerships (MLPs) | | | | by companies which are truly private, but some of |
| MLPs are also a special form of structure. In fact, | | | | the private equity firms have themselves decided to |
| they are not corporations at all, but partnerships. By | | | | go public, becoming BDCs. (Never mind that the size |
| law, their activities are limited to the production, | | | | and nature of the resulting entity and its investments |
| processing, and transport of natural resources, plus | | | | may be far outside the original purpose and spirit of |
| some operations in real estate. | | | | the law.) When a private equity firm is itself public, |
| MLPs appear mostly in the oil and gas industry. They | | | | that means that the individual investor has a chance |
| provide small investors a way to participate in pipeline | | | | to participate in "big deals" that would otherwise not |
| partnerships and other oil and gas operations that | | | | be possible. |
| otherwise would not be possible. Because the shares | | | | The law requires BDCs to at least annually distribute |
| trade, beyond the partnership distributions there is | | | | the bulk of their net investment income and capital |
| also the usual potential for capital gain or loss. | | | | gains to shareholders. Thus they often have |
| Every MLP has a general partner which manages and | | | | attractive dividend yields. As with REITs, these |
| controls the partnership. Shareholders in MLPs | | | | dividends are not subject to the 15% cap on dividend |
| (technically "unit holders") are limited partners in the | | | | tax rates for their recipients. And since the shares of |
| enterprise. They own an interest in the assets of the | | | | BDCs trade, there is the potential for capital gain or |
| business, which in turn entitles them to dividends and | | | | loss associated with any public company. |
| other distributions, and also to benefit from | | | | |