Monday, June 20, 2011

Kinder Morgan Partners – One Company three ways to invest in it

Kinder Morgan Energy Partners, L.P. owns and manages energy transportation and storage assets. This master limited partnership has consistently increased distributions since 1997.

There are three ways to invest in the partnership:

The first is by purchasing the limited partner units traded on NYSE under ticker (KMP). These are limited partnership units, which generate K-1 tax forms to unitholders. Most of the distributions which investors receive on a quarterly basis represent a return of capital, which means that it is not taxable unless investors decide to sell their units or unless their cost basis drops below $0. This return of capital reduces the cost basis of investors. The lower cost basis would trigger capital gains when units are sold. When the tax basis drops below $0, any distributions are taxed as ordinary income. I have analyzed Kinder Morgan Partners (KMP) in this article.

The second is by purchasing the LLC units traded on NYSE under ticker (KMR). KMR is a limited partner in and manages and controls the business and affairs of KMP. KMR has no properties and its success is dependent upon its operation and management of KMP and KMP's resulting performance. The only asset that KMR owns is KMP shares. Investors in KMR do not receive cash distributions, but receive shares proportional to the ownership interest they have in the stock. The cash distributions for KMP and KMR are equal, the only difference is that KMR distributions are paid in the form of additional shares.

The third way in investing in Kinder Morgan is by purchasing shares in the general partner interest, which recently started trading on NYSE under ticker (KMI). KMI owns the general partner and limited partner units in KMP. KMI also owns 20 percent of and operates Natural Gas Pipeline Company of America (NGPL), which serves the high-demand Chicago market. Another valuable asset behind KMI is the Incentive distribution rights behind the general partner, which entitles it to 50% of the distributions above certain thresholds. This is why any growth in KMP distributions would really accelerate growth in KMI dividends. KMI is set up as a corporation, which is why investors should receive a form 1099- DIV at the end of the year and have their dividends taxed at no more than 15%.

I purchased the i-units of KMR since I am in the accumulation phase and since they are trading at a steep discount to KMP units. It is true that KMR shares do not offer a “cash payment” per se, although investors could sell the additional shares received each quarter and obtain cash income that way. Investors could purchase KMR and hold it in tax deferred retirement accounts such as ROTH-IRA’s for example, without worrying about the unrelated business tax income (UBTI). Although in a previous article I have discussed why I do not believe the UBTI is an issue for tax-deferred accounts, nevertheless some investors might still worry about this potential tax penalty.

I also purchased KMI as a dividend growth play. While the yield is decent at 4%, I view the company to have excellent dividend growth potential.

Full Disclosure: Long KMR and KMI

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This article was included in the Carnival of Personal Finance #315 : Bring on the Long Weekends


  1. I've always thought distributions in excess of basis (after basis reaches $0) constituted capital gain. What makes you say they are ordinary income?

  2. Hi DGI, congrats on your blog.

    Yahoo says that KMI pays a dividend of 0,56$ (1.90%). How do you get the 4% yield?

    By the way, talking about MLPs/GPs, what do you think about AHGP/ARLP? Will they deserve an analysis from you?

    I usually prefer the higher growth of the GP than the better yield of the MLP.

    I'm also keeping an eye on El Paso Corp once it spins off its exploration business


  3. Kevin,
    DGI is correct, once cost basis goes to zero, the distributions are no longer tax deferred and taxed at regular income levels.

    I posted on the exact same topic this weekend, all this is still fresh in my head! :)

  4. The 1.90% yield quoted by Yahoo is based on the first dividend of 14¢, which would be 56¢ for four quarters. However, if you read the dividend announcement... see that the 14¢ was a "partial" dividend based on the portion of the quarter that followed KMI going public. The announcement states that the equivalent for a full quarter would be 29¢, which the SA quote page projects to $1.16/year. But at the current price, that puts the yield at about 3.9%.

  5. Because Investors in KMR recieve units, the cost per share cannot go to zero. So, upon dispersion will KMR be taxed as capital gain?

  6. Does anyone have a reference or citation re tax status of distributions from KMP after cost basis goes to zero? KMP investor relations tells me that they are "capital gains", my accountant and the IRS don't know. Help.

  7. Just spoke to the IRS, who say that the answer to the question of tax status of post-zero-cost-basis distributions is found in the instructions to Form 1065 K-1 for Box 19, and that if you've held the mlp (KMP in this case) for more than a year, the post-zero distribution would be reported on Schedule D as LONG-TERM CAPITAL GAIN.


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