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January 11, 2012

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Your MLP Tax Questions Unanswered

A few months ago, in this post, I was very excited to announce a pending guest blog post by Tim Fenn, in which he would answer your tax questions.  It was very gracious of Tim to agree to provide free content to the blog and all of you seemed very excited to get some answers.  I was excited to have my first guest post.
Everything looked good to go, but when Tim threw himself at the mercy of the nameless, faceless attorneys of his Ethics Committee to check on whether he could do the post, he was shut down.  Apparently, giving legal advice to non-clients is an issue.

Supreme Court HDR
       (decision came down from on high: there will be no MLP Tax Q&A)

I understand all of that, but I thought since each of you took the time to write out some very good questions, I would list them here and maybe the crowd (or in the case of this blog, small gathering) can source the answers.  I will answer a few, but please understand, I am not an attorney or an accountant, so like every genius person on Seeking Alpha that writes about MLP taxes, don’t take my advice, check with a CPA or tax attorney.
Your Questions 
UBTI recapture in an IRA? When you sell an MLP in any account, there is ordinary income recapture.  But in an IRA, is there anything such as UBTI recapture?  In other words, beyond the annual UBTI tax (assuming you are above the $1,000 threshold) is there some cumulative UBTI tax that is triggered when I sell an MLP I have owned for a long time in an IRA?

  • When you sell an MLP in a regular taxable account, the difference between your original purchase price and your adjusted basis (adjusted down for distributions, and up for allocated income) is recaptured at ordinary income tax rates.  The difference between your selling price and the original purchase price is taxed at capital gains rates.
  • When you sell an MLP in a IRA or otherwise tax-exempt account, the part that would have been considered ordinary income recapture above would be taxed at UBTI’s graduated tax rates (for any amount above $1,000).  So, there are two components of UBTI: the annual UBTI that gets allocated each year, and there is the UBTI recapture upon sale.

Step up in Basis: What happens to the cost basis of an MLP unit once a holder dies and the unit is passed on to their heirs?

  • Stepped up.

Tax Reform and MLPs: What is the general feeling of experts you speak with in regards to any changes in the tax status of MLPs as partnerships? Is there something that might happen in the next 12 months to increase the risk of a change in MLP tax status?
Funds vs. Direct Ownership: Without getting into too much detail could you give a brief description on the difference between owning a closed-end MLP fund and owning the MLP unit directly.
Distribution Reinvestment: If you reinvest distributions each quarter over many years, is your tax basis tracked on a net position basis (i.e. one position per partnership) or for each specific trade of the MLP?
Mineral Depletion: Can you explain the mineral depletion allowance for coal royalty MLPs? What is it, how is it calculated, what does it offset, it is true that depletion (unlike depreciation) does not get recaptured on sale? How does it impact cost basis?
Renewable MLPs: Do you think some day there will be renewable MLPs, like wind or solar energy MLPs?  What about water distribution and storage MLPs?
Qualified: You get asked all the time about whether something produces qualifying MLP income, what is the wildest asset class you have been asked about?
Basis: How do you calculate your current tax basis in an MLP from the info provided on a K-1.  Do suspended losses add to basis?  If so, presumably the suspended losses are “consumed” by distributions, and how does one properly account for that?  I think that the whole question of basis is something of a mystery to many people, and a thorough review would be appreciated by all.
C-Corp Purchases by MLP: My question is in relation to the recent MLP deals involving an MLP acquiring C corporations (e.g. Kinder Morgan/El Paso Corporation and Energy Transfer/Southern Union Company) – Obviously, the fact that the underlying assets acquired are within corporate solution minimizes the overall tax efficiency of the MLPs’ traditional operating structure from a tax perspective.  Liquidating these C corporations would come at a substantial tax cost, however, do you see this as a possibility with respect to these companies or would you at least expect a distribution of the qualified assets (considering the tax cost of this as well under 311(b)) at some in the future?  In other words, does it appear to you that these MLPs intend to maintain the business of the C corporation targets within corporate solution or to migrate them towards more of a traditional MLP flow through structure.  Further, do you anticipate that this trend in MLPs acquiring C corporations will continue?
Good questions everyone, feel free to give your own free and unauthorized legal and tax advice in the comments below.
Disclosure: The information in this article is not meant to be financial advice, we are not your financial advisor and I am posting my comments for informational purposes only. 

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