Douglas Rachlin: His income portfolio is up 18% a year.

Portfolio manager Douglas Rachlin made two big moves in 1996. First, he started putting his clients into master limited partnerships, which are a tax-savvy way to own energy-related assets like pipelines. Second, he folded his tiny money management firm into Lehman Brothers ( LEHMQ - news - people ).

The latter move was perhaps not so smart, given what happened 12 years later. The first was brilliant. In the just over 14 years since then Rachlin's MLP strategy has earned a compound annual return (net of fees) of 18%, which is three times the S&P 500's. The tax benefits to the partnerships have been icing on this cake.

Not without bumps along the way, however. MLPs crashed harder than the stock market in 2008. Now they're coming back. Rachlin, 47, and four deputies manage $2.1 billion of the $180 billion in client assets at Neuberger Berman. (Neuberger broke free from bankrupt former parent Lehman.)

Given that fees on Rachlin's Income Plus Portfolio range up to 1.5%, his group appears to be hauling in $25 million a year or more in revenue. So far it has earned its keep, delivering results well ahead of those for the Alerian index of MLPs.

Is this sector still a buy?

Answering that involves considering both investment returns and the tax angle. The returns will probably be pretty good, albeit nothing like those in the MLP industry's early days. The tax advantage is still considerable for those with upper-bracket incomes who play their cards right.

### Profits

The granddaddies of the MLP business, Kinder Morgan Energy Partners ( EPL - news - people ) and Enterprise Products Partners ( EPD - news - people ), have each given rise to fortunes on the FORBES list of billionaires. Both transport energy and own pipelines, tank farms and shipping terminals. They collect fees for moving products and don't much care about the price of natural gas or crude oil. The appeal to investors is a fat (and so far steadily rising) dividend payout.

In sorting through MLPs, Rachlin pursues three big themes: natural gas, corporate youth and general partnership shares.

In natural gas handlers' favor is the recent development of gas-bearing shale that should mean higher volumes to be gathered, processed and transported. Example: Inergy, ( NRGP - news - people ) whose gas storage (salt caverns in western New York) is a gateway between midwestern sources and New England consumers. It also owns a fleet of propane trucks. It's yielding 7.1%.

Rachlin likes new MLPs set up by old, well-established businesses. His hope is that the parent company will continue to feed in assets, leading to above-average growth in the new partnership's early years. Three-year-old El Paso Pipeline Partners offers a relatively modest 4.9% yield, but the dividend should rise nicely as sponsor El Paso Corp. ( EP - news - people ) sends more buried steel its way.

Publicly traded partnerships always have limited partner shares available; in some cases the public can also buy shares of the general partner, which controls the business and collects higher percentages of profits as they go up. Rachlin will usually opt for a general partnership stake over a limited partnership one, sacrificing current income for the prospect of better growth. Case in point: Rachlin prefers Energy Transfer Equity, general partner of a Southwestern pipeline owner, to Energy Transfer Partners ( ETP - news - people ), its higher-yielding sister LP.

Among Rachlin's few nonenergy plays is Cedar Fair ( FUN - news - people ), whose 11 amusement parks should be able to deliver $350 million in net this year before interest, taxes, depreciation and a nonrecurring item. Its enterprise value (debt plus market value of the equity) is only seven times that sum. Cheap if you don't mind a roller-coaster investment.

Don't count on Rachlin racking up anything like his earlier 18% annual returns. Start with this fact: Assuming investors' willingness to pay for a dollar-a-year stream of income doesn't change, the total return on an income vehicle equals its yield plus the growth rate in the dividend.

Yields on these MLPs are in the neighborhood of 5% and growth prospects around 8%. Bear in mind that some are enjoying growth spurts that will taper off. Rachlin says a 10% to 15% annual return is a reasonable target for MLP investors.

Risks? Considerable. Not only is a mauling in another market crash possible, but you're getting a heavy dose of exposure to a fossil fuel industry that is in the crosshairs of every environmentalist.

### The Tax Angle

Partnerships have more money to dish out to investors than similarly profitable corporations because they are largely exempt from corporate income taxes. Instead, profits flow through to shareholders, who pay individual taxes on them. In this regard, MLPs are similar to real estate investment trusts, but with one big advantage: Energy MLPs' fat depreciation deductions mean that investors don't pay much tax on the profits, either.

Unless and until Congress intervenes, those benefits are considerable. A capital-intensive energy partnership pays dividends almost free of tax in the early years of your investment. After a decade or two the dividends become fully taxable. The crossover point comes, roughly speaking, when your cumulative dividends equal what you paid for your shares. If you sell out, you will get a belated tax bill (at ordinary income rates) for any dividends that escaped taxation before.

You pay a price for the deferral in the form of complexity. Remember that quip about the 1040 tax form? Fill out the short form and give all your money to the IRS, or fill out the long form and give all your money to your accountant.

You have that choice here. Buy Exxon and your dividends are taxed at stiff rates (44.6% plus state taxes beginning in 2013, if Obama and Congress don't compromise on a tax cut). Or buy Enterprise Products Partners and tangle with a K-1 form every March.

If you want to know more about how taxes work with depreciation-heavy limited partnerships, Google ( GOOG - news - people ) "site:forbes.com MLP taxation." Meanwhile here are four rules to guide you:

- Stay away from MLPs unless you can commit at least $100,000. The accounting bills won't be worth it.
- Do buy if you are getting on in years. That back-tax bill for the untaxed dividends is forgiven when you die.
- Don't own MLPs in an IRA or other tax-deferred account, or you'll wind up in "unrelated business taxable income" quicksand.
- Don't give MLP shares to charities. Donate shares of Exxon and you escape tax on the appreciation; with energy MLPs you'll get hit with that catch-up tax.

#### High Energy

These master limited partnerships offer plentiful dividend payouts, promising growth prospects and a way to keep most gains from uncle sam. the downside: tax complexities that are staggering even for the IRS.
|  | Dividened |
Company | Recent price | yield | payout growth* | Business
Alliance Holdings GP | $43 | 4.7% | 24% | general partner in a coal mine
El Paso Pipeline Partners | 34 | 4.9 | 14** | natural gas pipelines and storage
Energy Transfer Equity | 40 | 5.4 | 11 | general partner in two natural gas handlers
Enterprise GP Holdings | 64 | 3.6 | 13 | general partner of Enterprise Products
Enterprise Products Partners | 43 | 5.4 | 6 | diversified energy shipper and processor
Inergy | 40 | 7.1 | 6 | natural gas storage and propane distribution
NuStar GP Holdings | 36 | 5.4 | 4 | general partner of oil and asphalt handler
Oneok | 50 | 3.8 | 10 | taxable corp with GP interest in gas handler
Regency Energy Partners | 25 | 7.0 | 5 | natural gas gathering and handling
Spectra Energy Partners | 35 | 5.0 | 14 | natural gas pipelines and storage
Prices as of Nov. 3. *3-year compound annual growth in payout. **Annualized growth over 23/4 years. Sources: Interactive Data via FactSet Research Systems; Neuberger Berman.