With April 15 just around the corner, if you're like me, you're looking for ways to permanently reduce your tax bill. The good news is that there are investments that not only cut your taxes, but also deliver high yields. Some of these are small niche investment vehicles and not well-known. But with the right tools, you can be smarter than the crowd and use these to your advantage.
Here are three of the best investments you can make to lock in tax-advantaged high yields.
1. Master Limited Partnerships (MLPs)
Master limited partnerships (MLPs) have a track record for consistent growth, steady returns and high yields that are mostly tax-free. In addition, many energy MLPs own oil and gas pipelines and are poised for strong growth right now because of renewed domestic drilling, which is increasing demand for pipelines and terminals for transportation of these resources.
A benchmark MLP index yielded 6% last year, and several MLPs currently offer payouts near 8%. The MLP sector is relatively new, but proved its resiliency during the recession, when only a handful of MLPs cut distributions. So while these vehicles might not be barn-burners in terms of price performance, they offer relatively safe, stable dividends with a moderate degree of price return to boot.
A portion of MLP payouts are often tax-deferred, creating tax advantages for investors. In fact, due to big depreciation allowances, as much as 90% of the distribution is classified as return of capital and not taxable in the current year. Instead, return of capital reduces the cost basis of the MLP investment and isn't taxed until units are sold (ownership in an MLP is in "units" rather than shares).
For example, if you pay $25 for a MLP unit and receive $4 in distributions ($3.50 of which is a return of capital), the cost basis of your investment declines to $21.50 after the first year ($25 minus $3.50) and you pay no taxes on the $3.50 until you decide to sell.
You maximize the tax deferral benefit by holding MLP units for longer periods. These are especially attractive investments if you plan to retire in a few years and will be moving into a lower tax bracket.
MLPs I especially like include Enbridge Energy (Nasdaq: EEP), which owns pipelines in the mid-continent and Gulf Coast regions and is spending $110 million to expand gathering capacity.