A Master Limited Partnership (MLP) is a publicly traded partnership which meets the IRS requirements to be taxed as a partnership. The income is passed through on a Form K-1 to be taxed on the share-holder's individual income tax return.
The main advantage of the MLP form of ownership is that the double taxation of the corporate form of ownership is avoided (where profits are taxed at the corporate level and taxed again when dividends are paid to shareholders.)
Owners of substantial holdings may be required to file income tax returns in the states in which the MLP operates if their allocated profits exceed the state filing limits. However, investors in typical retail quantities will usually fall below the state filing limits.
Because of the highly efficient tax structure, generous yields, and secondary market liquidity, many sophisticated investors are interested in including MLP's in their investment portfolios.
The determination of cost basis for MLP's is tricky because it is NOT the original purchase price, despite what appears on your brokerage account statements. You have to adjust your cost basis for all the income which was passed through on all the K-1 forms since you bought it, and reduce it for the cash distributions you received from the MLP. The K-1 package often includes a schedule which makes this basis calculation for you.
Passive losses on MLP's are subject to the passive activity loss limitation rules (you definitely need to see your accountant on this one.) In addition, the passive loss from a MLP cannot be used to shelter passive income from a second MLP; the passive losses are "suspended" until they can be applied to future passive income from the same MLP.
Prominent examples of MLP's include: The Blackstone Group - BX Buckeye Partners LP - BPL Constellation Energy Partners LP - CEP Genesis Energy LP - GEL Kinder Morgan Energy Partners LP - KMP ONEOK Partners LP - OKS Plains All American Pipeline LP - PAA Sunoco Logistics Partners LP - SXL Terra Nitrogen Co LP - TNH Williams Pipeline Partners LP - WMZ
CAUTION: You don't want to buy any MLP's in an IRA! Why? You are creating a UBIT problem for yourself. UBIT is Unrelated Business Income Tax which is owed on business income passed through on the Form K-1. It is owed even if the MLP is held inside an IRA. Why is this a problem? Because first you pay income tax on the income inside the IRA, and then you pay again when you withdraw distributions from your IRA (taxed at your marginal ordinary income tax rate.) You just created a double tax for yourself.
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Information provided is intended solely for U.S. individual cash-basis taxpayers and is believed to be accurate for most cases. Always consult your personal tax advisor about your own situation. Suggestions are most welcome. Please e-mail webmaster @ costbasis.com or write to us at P O Box 11022, Chicago IL 60611 with your comments.