Publicly traded Master Limited Partnerships

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Publicly traded Master Limited Partnerships

Postby EmergDoc » Sun Mar 13, 2011 4:50 pm

It seems there is a bit of a resurgence in Master Limited Partnerships, including a number of them which are traded publicly. Many of them seem to be concentrated in the energy sector, particularly pipelines and transport.

As I understand it, there is no benefit of the MLP structure to someone investing in a tax-protected account (correct me if I'm wrong) but it is an interesting phenomenon. I wonder if it could be considered, like REITs, a separate asset class. There is even an index that tracks these, and, you guessed it, an ETN that follows the index (albeit at a 0.85% ER.) You could certainly buy that in an IRA and it is reasonably liquid.

Anyone with experience in this area that would like to weigh in on the topic? I checked my copy of Swedroe's Only Guide to Alternative Investments and didn't see it mentioned.
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Postby Eric » Sun Mar 13, 2011 5:44 pm

Be careful about buying MLPs directly in an IRA. IRAs are subject to tax on "unrelated business taxable income" (UBTI), which MLPs often generate. There's a brief discussion of the issue in this Wall Street Journal article.

(I'm not sure why they mention converting to a Roth IRA, though, because as the article itself acknowledges, the UBTI problem applies to Roth IRAs too.)
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Postby Tiekoon » Sun Mar 13, 2011 6:15 pm

Doc

Yes indeed, the chase for yield has certainly brought MLP’s to the forefront of late. Needless to say, the sudden popularity has most now priced to perfection INHO but, still a nice yield, plus growth/consolidation. I have had several pipeline MLP’s in my income portfolio (KMP, BPL, PAA & EPD) for years and been rewarded handsomely. I continue to add more on weakness.

You are correct to question holding an MLP in your IRA. Over $1000 in income will trigger UBTI, which I understand can complicate your tax return. See better explanation here at Dividend Growth Investor MLP’s for tax-deferred account> http://www.dividendgrowthinvestor.com/2009/05/mlps-for-tax-deferred-accounts.html


As for getting a grasp on the MLP structure and differences in companies, I would highly recommend reading this MLP Primer by Well Fargo >
http://www.naptp.org/documentlinks/Investor_Relations/WF_MLP_Primer_IV.pdf

Good luck to you…
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Postby fredflinstone » Sun Mar 13, 2011 6:19 pm

MLPs are tax-efficient and I bought them in early 2010 for that reason. However, I recently sold them because I wanted to streamline my portfolio and make my taxes simpler. I do not consider MLPs a separate asset class. Even within the category there is some diversity (mostly natural gas pipelines, but also a cemetery company and an amusement park company).
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Postby pshonore » Sun Mar 13, 2011 6:40 pm

Most MLPs generate negative UBTI. There are of course exceptions - some of the E&P MLPs like VNR, EVEP, BBEP etc that extract O&G tend to to have positive UBTI. But the big guys (EPD,KMP, etc) have generated negative UBTI for the past severaL years.

The $1000 limit on income refers to the net operating income of the MLP (Box 1 of the K1) and NOT to distibutions received.

One last point - two MLPs (EEQ and KMR) distribute cash flow thru PIK (pay in kind shares - like a mini stock split), don't produce a K1 and also don't produce a 1099 until you sell. No taxable events
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Postby Eric » Sun Mar 13, 2011 9:58 pm

pshonore wrote:One last point - two MLPs (EEQ and KMR) distribute cash flow thru PIK (pay in kind shares - like a mini stock split), don't produce a K1 and also don't produce a 1099 until you sell. No taxable events


I think these two entities avoid the tax problem only by substituting a different tax problem. KMR's web site states that it has elected to be treated as a corporation rather than a partnership for federal tax purposes. This avoids the IRA-level tax by substituting a corporate-level tax. That simplifies the shareholder's tax reporting but the shareholder still bears (indirectly) a tax cost, you just don't see it. EEQ's web site doesn't address the issue as clearly but I assume it has a similar structure.
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Postby pshonore » Sun Mar 13, 2011 10:16 pm

Are you sure you're looking at KMR's website? What you're quoting sounds like the new IPO for KMI which is the GP for KMP (Does this sound like alphabet soup?) The GP used to be publicly traded. Richard Kinder took it private a few years back and they did an IPO in the last few weeks.
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Postby Eric » Sun Mar 13, 2011 10:33 pm

pshonore wrote:Are you sure you're looking at KMR's website? What you're quoting sounds like the new IPO for KMI which is the GP for KMP (Does this sound like alphabet soup?) The GP used to be publicly traded. Richard Kinder took it private a few years back and they did an IPO in the last few weeks.


Hmm. I don't see the discussion I remember reading earlier, but here's an SEC filing for KMR that says the same thing. At the bottom of page 5 of the filing:

We have elected to be treated as a corporation for federal income tax purposes. Because we are treated as a corporation for federal income tax purposes, an owner of our shares will not report on its federal income tax return any of our items of income, gain, loss and deduction relating to an investment in us.


Also see the top of page 4:

In this report, unless the context requires otherwise, references to “we,” “us,” “our,” or the “Company” are intended to mean Kinder Morgan Management, LLC and its consolidated subsidiary. Our shares representing limited liability company interests are traded on the New York Stock Exchange under the symbol “KMR”
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Postby pshonore » Sun Mar 13, 2011 11:00 pm

Eric wrote:
pshonore wrote:Are you sure you're looking at KMR's website? What you're quoting sounds like the new IPO for KMI which is the GP for KMP (Does this sound like alphabet soup?) The GP used to be publicly traded. Richard Kinder took it private a few years back and they did an IPO in the last few weeks.


Hmm. I don't see the discussion I remember reading earlier, but here's an SEC filing for KMR that says the same thing. At the bottom of page 5 of the filing:

We have elected to be treated as a corporation for federal income tax purposes. Because we are treated as a corporation for federal income tax purposes, an owner of our shares will not report on its federal income tax return any of our items of income, gain, loss and deduction relating to an investment in us.
Note the next paragraph after your quote
We are subject to federal income tax on our taxable income; however, the i-units owned by us generally are not entitled to
allocations of income, gain, loss or deduction of Kinder Morgan Energy Partners until such time as there is a liquidation of Kinder
Morgan Energy Partners. Therefore, we have not had, and do not expect to have material amounts of taxable income resulting from our ownership of the i-units unless we enter into a sale or exchange of the i-units or Kinder Morgan Energy Partners is liquidated
I can only add KMR distributes the same amount as the LP (KMP) except it in additional shares of KMR
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Postby Eric » Sun Mar 13, 2011 11:08 pm

But I think that just moves the tax up yet another level. We'd have to dig into the tax treatment of Kinder Morgan Energy Partners, and perhaps follow that through to yet more entities in the chain, but ultimately someone has to pay the tax (if there is income). In tax law, as elsewhere, TANSTAAFL generally holds. Not always, but generally.
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Postby LH » Sun Mar 13, 2011 11:35 pm

http://online.wsj.com/article/SB124786482493759951.html

When held in taxable accounts, MLPs provide some attractive tax advantages. Because of its structure, an MLP gets to pass its depreciation of assets and expenses through to investors, who may be able to use the pass-through expenses to reduce or eliminate the tax on the income received from that particular investment, Mr. Stahler says.

But you would lose that tax advantage by holding MLPs in a tax-deferred individual retirement account, and you have to pay ordinary income tax on any distributions you eventually take, says Ed Slott, an IRA consultant in Rockville Centre, N.Y.

And if an MLP investment generates what is known as "unrelated business taxable income," which is likely, the IRA has to file a separate tax return and pay any tax involved from assets in the account, Mr. Slott says.


To me, the above three paragraphs kinda sums it up. They have some tax advantages, then they have tax disadvantages. Then they have tax complexity, where you need an expert to figure out if you need to file another return or not (and posters often argue over this if I recollect right, which means it may be a gray area).

I mean, listen to Eric:
But I think that just moves the tax up yet another level. We'd have to dig into the tax treatment of Kinder Morgan Energy Partners, and perhaps follow that through to yet more entities in the chain, but ultimately someone has to pay the tax (if there is income). In tax law, as elsewhere, TANSTAAFL generally holds. Not always, but generally.


Uh..... Ok. I just do not really follow all that at all, seems really vague. Eric may have it dead on, but I just do not know. But even if Eric is dead on, look, there is the typical MLP tax caveats thrown in, "i think", (if there is income), entities in the chain, then ending with TANSTAAFL generally holds "not always, but generally." A double "generally"! That uncertain type talk, is a MLP reoccurring theme. Its not Erics fault its written with all the caveats. Thats MLPs, near everytime I read about them.

That above, pretty much does it for me as even starting to consider it an "asset class" which does not make it NOT an asset class per se. But whoa. I do not need the hassle, and to gameplay the tax stuff, would take some serious digging, then some serious thought, in the face of seeming just plain uncertainty on the tax law on people on may assume are a couple clicks above me in knowledge.

Then consider this: the tax stuff may change. Its not like a house mortgage exemption (which may change too) in that if MLP tax law changes, on overwhelming average, no one will give one rats butt about it.

Then there is non-systemic risk you are taking, its not like they are huge numbers of these things.

There there is the asset class "feel", and this stuff is weak I admit. I mean, take REITS, land has been around a long time. 1/3rd land, 1/3 business, 1/3 reserve(bonds/cash). Convert those to 1/4, and add in gas pipelines? Tongue in cheek there : ) But you know, that does not feel right per se, for what its worth. Compared to doing the same thing for, say, 1/4th commodities, well, ok, reasonable feel, broad general class. But 1/4th gas pipelines?

In sum:
1)is it an "asset class" I dunno. seems vague
2)is it worth it tax wise. I dunno. seems vague
3)3 years into it, will I have to refile my taxes cause I/accountant screwed up the MLP? I dunno, maybe?

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Postby pshonore » Sun Mar 13, 2011 11:39 pm

KMP is an LP and does not pay tax. Income and losses are passed through to the Partners who report them on their tax return. Of course, KMP has never reported a profit (Box 1 of the K1) as far as I know. However a partner's basis gets reduced by all those "distributions" and some of that will be recaptured as Ordinary Income when an partner sells their interest. So there will be a potentially large tax bill down the road. (unless the partner dies and passes his units to his heirs who get a step in basis)
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Re: Publicly traded Master Limited Partnerships

Postby saurabhec » Sun Mar 13, 2011 11:46 pm

EmergDoc wrote:It seems there is a bit of a resurgence in Master Limited Partnerships, including a number of them which are traded publicly. Many of them seem to be concentrated in the energy sector, particularly pipelines and transport.

As I understand it, there is no benefit of the MLP structure to someone investing in a tax-protected account (correct me if I'm wrong) but it is an interesting phenomenon. I wonder if it could be considered, like REITs, a separate asset class. There is even an index that tracks these, and, you guessed it, an ETN that follows the index (albeit at a 0.85% ER.) You could certainly buy that in an IRA and it is reasonably liquid.

Anyone with experience in this area that would like to weigh in on the topic? I checked my copy of Swedroe's Only Guide to Alternative Investments and didn't see it mentioned.


I wouldn't buy them now, but I think it is completely fair to consider MLPs and Regulated utilities as alternatives to REITs. Theoretically unlikes REITs they are not real assets, but I think they share similar attributes as industries where growth is relatively modest and there is some inherent ability to pass on inflationary cost increases in a relatively low risk manner.
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Postby stratton » Mon Mar 14, 2011 1:10 am

Tiekoon wrote:As for getting a grasp on the MLP structure and differences in companies, I would highly recommend reading this MLP Primer by Well Fargo >
http://www.naptp.org/documentlinks/Investor_Relations/WF_MLP_Primer_IV.pdf

Thanks. When I looked several months ago this hadn't been updated. The previous one was from early 2007 or 2008.

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Postby stratton » Mon Mar 14, 2011 1:13 am

I consider MLPs one of the few infrastructure investments an individual investor can make. Most "infrastructure" investments appear to be utility funds in disguise with a higher ER.

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Postby denismurf » Mon Mar 14, 2011 3:13 am

ENY gets you a spread of Canadian energy cos, for a .7% ER. I've only had it a couple of months and hope it eliminates some of the tax complexities inherent in the stocks it holds. I confess I didn't look too carefully at this before I leapt.
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Postby indexfundfan » Mon Mar 14, 2011 3:26 am

I do get taxed by the fractional shares from KMR and EEQ's PIK distributions. This is because the broker did not allow holding fractional shares.

I have since moved KMR and EEQ to VBS. I hope they will not liquidate the fractional shares.
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Postby Eric » Mon Mar 14, 2011 7:23 am

pshonore wrote:KMP is an LP and does not pay tax. Income and losses are passed through to the Partners who report them on their tax return. Of course, KMP has never reported a profit (Box 1 of the K1) as far as I know. However a partner's basis gets reduced by all those "distributions" and some of that will be recaptured as Ordinary Income when an partner sells their interest. So there will be a potentially large tax bill down the road. (unless the partner dies and passes his units to his heirs who get a step in basis)


OK, but let's unpack this. You're not saying that the structure itself somehow avoids the tax. The organizer hasn't found some special sauce that makes the tax, if there is any, go away. You're just saying that there is currently no income to tax, after taking into account all the deductions, credits, etc. that are available in this industry. (And if there ever is taxable income at the "subsidiary" level, the corporate status of the "parent" will keep that income from hitting the end investor's tax return. Instead, the tax will be reported and paid at the parent entity level.)
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Postby pshonore » Mon Mar 14, 2011 8:27 am

Eric wrote:
pshonore wrote:KMP is an LP and does not pay tax. Income and losses are passed through to the Partners who report them on their tax return. Of course, KMP has never reported a profit (Box 1 of the K1) as far as I know. However a partner's basis gets reduced by all those "distributions" and some of that will be recaptured as Ordinary Income when an partner sells their interest. So there will be a potentially large tax bill down the road. (unless the partner dies and passes his units to his heirs who get a step in basis)


OK, but let's unpack this. You're not saying that the structure itself somehow avoids the tax. The organizer hasn't found some special sauce that makes the tax, if there is any, go away. You're just saying that there is currently no income to tax, after taking into account all the deductions, credits, etc. that are available in this industry. (And if there ever is taxable income at the "subsidiary" level, the corporate status of the "parent" will keep that income from hitting the end investor's tax return. Instead, the tax will be reported and paid at the parent entity level.)
No, I'm not saying that. KMR is a partnership. Partnerships do not pay tax. All income (if any) is passed through to the partners where it is taxed. KMR is a special share class of KMP which pays out in PIK shares rather than cash. No tax due until you sell the shares. Then at Cap gains rates.
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Postby Eric » Mon Mar 14, 2011 9:46 am

pshonore wrote:No, I'm not saying that. KMR is a partnership. Partnerships do not pay tax. All income (if any) is passed through to the partners where it is taxed. KMR is a special share class of KMP which pays out in PIK shares rather than cash. No tax due until you sell the shares. Then at Cap gains rates.


Actually, no. KMR is a partnership for state law purposes. However, it has elected to be treated as a corporation for federal tax purposes. (Per its SEC filing, quoted above.) Corporations pay tax, if they have any taxable income.

Unfortunately as to the rest of it, I think we're talking past each other or not understanding what the other person is saying. I need to take the time to walk through the issues in detail, but unfortunately I can't this morning. Will try at lunch if I have time.
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Postby Wagnerjb » Mon Mar 14, 2011 10:23 am

EmergDoc: there is a fair amount of misunderstanding about MLPs. Here are two of the biggest ones in my mind.

1) MLPs are tax efficient. This isn't clear to me. Let's compare them to dividend paying stocks. With an MLP, you pay tax on the partnership income - not on the amount distributed. This leads to very low taxation of the actual cash distribution. You see most people indicate that something in the range of 80% of the amount distributed is not taxed (currently). The portion that is taxed is taxed at your ordinary income rate...say 33%. For a stock dividend, you pay tax on 100% of the distribution, at a rate of 15%.

When you sell the MLP, you pay tax on the amount of income that was distributed but not taxed earlier (the 80% of the distribution). You pay tax on this amount at ordinary income rates. (Additional gain over and above this recaptured amount is taxed as capital gain). When you sell a regular dividend paying stock, you have no "recapture", and you pay a capital gain on any increase in value.

So, what happens with an MLP (vs. stock) is that you defer payment of taxation - and that is why some folks consider them tax efficient. But you pay tax at 33%, not the dividend rate of 15%. I am not convinced that deferral plus a higher tax rate is a winning combination.

2) The MLP avoids double taxation, so the investor wins. Nope. Congress created MLPs to encourage investment in infrastructure in the US, especially energy infrastructure like pipelines, terminals and tankers. The law allowed the MLP structure and thus the taxation at the corporate level is avoided. But who benefits from this? The oil company does. They own the pipeline originally, and they spin it off into an MLP. When they spin it off, the price is set to allow investors a normal and fair rate of return....and investors jump at this opportunity. Since the oil company can get a high price for its MLP, it is more likely to invest in the infrastruture assets to begin with.

Think of this like Muni bonds. The government eliminates taxation on Muni's. Who gets this benefit? Not the typical investor. The Municipality does....as an incentive to invest in construction, etc. The Muni prices the bonds such that the typical investor is indifferent between taxable and tax-free. MLPs are the same. The government eliminated a layer of taxation, but that benefit doesn't go to investors.

Hope this helps.
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Postby pshonore » Mon Mar 14, 2011 10:52 am

Wagnerjb wrote:EmergDoc: there is a fair amount of misunderstanding about MLPs. Here are two of the biggest ones in my mind.

1) MLPs are tax efficient. This isn't clear to me. Let's compare them to dividend paying stocks. With an MLP, you pay tax on the partnership income - not on the amount distributed. This leads to very low taxation of the actual cash distribution. You see most people indicate that something in the range of 80% of the amount distributed is not taxed (currently). The portion that is taxed is taxed at your ordinary income rate...say 33%. For a stock dividend, you pay tax on 100% of the distribution, at a rate of 15%.

When you sell the MLP, you pay tax on the amount of income that was distributed but not taxed earlier (the 80% of the distribution). You pay tax on this amount at ordinary income rates. (Additional gain over and above this recaptured amount is taxed as capital gain). When you sell a regular dividend paying stock, you have no "recapture", and you pay a capital gain on any increase in value.
Actually, there is no way to tell ahead of time what the amount of recapture will be. It could be 20% of the portion not previously taxed; it could be 125% (effectively turning capital gain into ordinary income). You won't know until you receive the K1 with a Sales Schedule detailing that.

So, what happens with an MLP (vs. stock) is that you defer payment of taxation - and that is why some folks consider them tax efficient. But you pay tax at 33%, not the dividend rate of 15%. I am not convinced that deferral plus a higher tax rate is a winning combination.

2) The MLP avoids double taxation, so the investor wins. Nope. Congress created MLPs to encourage investment in infrastructure in the US, especially energy infrastructure like pipelines, terminals and tankers. The law allowed the MLP structure and thus the taxation at the corporate level is avoided. But who benefits from this? The oil company does. They own the pipeline originally, and they spin it off into an MLP. When they spin it off, the price is set to allow investors a normal and fair rate of return....and investors jump at this opportunity. Since the oil company can get a high price for its MLP, it is more likely to invest in the infrastruture assets to begin with.

Think of this like Muni bonds. The government eliminates taxation on Muni's. Who gets this benefit? Not the typical investor. The Municipality does....as an incentive to invest in construction, etc. The Muni prices the bonds such that the typical investor is indifferent between taxable and tax-free. MLPs are the same. The government eliminated a layer of taxation, but that benefit doesn't go to investors.

Hope this helps.
The major advantage appears to be tax deferral. The big MLPs (EPD, KMP, etc) generate no taxable income and the distributions run 5 - 6% per year. The ideal situation is to leave them to your heirs. They get a step in basis and owe no tax if they sell at that time.
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Postby fredflinstone » Mon Mar 14, 2011 11:55 am

Wagnerjb wrote:1) MLPs are tax efficient. This isn't clear to me. Let's compare them to dividend paying stocks. With an MLP, you pay tax on the partnership income - not on the amount distributed. This leads to very low taxation of the actual cash distribution. You see most people indicate that something in the range of 80% of the amount distributed is not taxed (currently). The portion that is taxed is taxed at your ordinary income rate...say 33%. For a stock dividend, you pay tax on 100% of the distribution, at a rate of 15%.

When you sell the MLP, you pay tax on the amount of income that was distributed but not taxed earlier (the 80% of the distribution). You pay tax on this amount at ordinary income rates. (Additional gain over and above this recaptured amount is taxed as capital gain). When you sell a regular dividend paying stock, you have no "recapture", and you pay a capital gain on any increase in value.

So, what happens with an MLP (vs. stock) is that you defer payment of taxation - and that is why some folks consider them tax efficient. But you pay tax at 33%, not the dividend rate of 15%. I am not convinced that deferral plus a higher tax rate is a winning combination.


very helpful explanation. It seems I bought the MLPs for the wrong reason. I am glad to be done with them. (They gave me a nice gain, so I guess I can't complain too much.)
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Postby jh » Mon Mar 14, 2011 12:16 pm

...
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Postby Eric » Mon Mar 14, 2011 12:56 pm

Let’s take this step by step.

1. An entity that’s treated as a partnership for federal income tax purposes doesn’t pay tax. Instead, its taxable income is passed through to the partners on a K-1.

2. An entity that’s treated as a corporation for federal income tax purposes does pay tax. Its owners don’t, except when they receive a dividend or sell their shares. (I’m ignoring special cases like S corporations.)

3. The federal tax treatment of an entity doesn’t always track its form under state law. An entity that’s established as a partnership under state law may nevertheless elect to be treated (and in some cases, is automatically treated) as a corporation for federal tax purposes.

4. Many years ago, Congress decided that most publicly traded entities would be automatically treated as corporations for federal tax purposes (i.e., the entity would get no choice in the matter). However, Congress made an exception for MLPs. MLPs can still choose to be treated as partnerships for federal tax purposes. That’s often seen as a benefit, because an MLP’s income is taxed only once (at the owner level), rather than twice (once at the entity level and again upon payment of a dividend).

5. This benefit comes with costs. One cost is that an investor receives a K-1 from a typical MLP (i.e., an MLP that is treated as a partnership for federal tax purposes). That complicates the investor’s tax reporting and can make the annual 1040 ritual more of a headache. Another cost applies to investors that are otherwise tax-exempt, like IRAs and charities. These investors pay a special tax, called the “unrelated business income tax” (UBIT), on their share of the MLP’s taxable income. The UBIT is designed to ensure that the MLP’s income is taxed at least once. Without the UBIT, that portion of the MLP’s income would escape income tax entirely.

6. The UBIT problem may be overstated in some cases, because many MLPs do not generate much taxable income in the first place, at least in the early years of their operations. Nevertheless, IRA investors and charities are understandably skittish about the possibility of incurring UBIT. No one likes to pay tax within what is supposed to be a tax-exempt account, even if the tax turns out to be relatively modest.

7. To increase their appeal to IRA investors and charities, some MLPs choose not to be treated as partnerships for federal income tax purposes. Instead, they elect to be treated as corporations for federal income tax purposes (or they establish a multiple-tier structure, and ensure that the top tier – the tier you invest in – is treated as a corporation for federal income tax purposes). This seems to be the approach KMR has taken. They can tell investors, “we don’t expect to have much taxable income for a while anyway, but if we do, it will be trapped inside a corporation and we’ll pay the tax there so you’ll never see it or have to worry about it.”

That’s fine as far as it goes. I just want everyone to understand that this doesn’t really solve the tax problem, it just simplifies tax reporting by the end investor. If the underlying operations generate any taxable income, someone will pay tax on that income.

All the usual caveats apply – this isn’t tax or legal advice, and you should consult your own tax advisor before investing in an MLP.
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Postby Eric » Mon Mar 14, 2011 1:02 pm

jh wrote:I haven't read the entire thread yet. So, this may have already been mentioned. You can buy an ETF of all the US MLPs in it. The ETF is AMLP.


Same issue as above. The ETF doesn't really solve the tax problem, it just simplifies tax reporting by the end investor by having an intermediary bear tax. Also, the ETF may increase the overall tax liability by causing tax to be imposed at two levels (the ETF level and the investor level). You don't see the tax that is imposed at the ETF level, but it is still a cost that you indirectly bear.

Update: Googled an article, "Beware of MLPs in ETF Wrappers." I haven't studied the article in detail to confirm its accuracy, am just posting quickly before grabbing a sandwich. But at first glance it seems to flag the problem.
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Postby aja8888 » Mon Mar 14, 2011 1:27 pm

I own a few MLPs in my taxable account. Their corporate website provides my with completed K-1's around March each year. This year, one even provided a download to import the K-1 into Turbo Tax. Inputting this info into my tax return has been straightforward. Took all of 5 minutes.

The MLPs I own in my tax deferred account don't generate enough income to make the $1000.00 limit, therefore, it's not a worry.
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Postby Wagnerjb » Mon Mar 14, 2011 1:47 pm

pshonore wrote:Actually, there is no way to tell ahead of time what the amount of recapture will be. It could be 20% of the portion not previously taxed; it could be 125% (effectively turning capital gain into ordinary income). You won't know until you receive the K1 with a Sales Schedule detailing that.


I understand. But you need an assumption or expectation in order to evaluate whether the investment is appropriate for you. I don't know why we shouldn't use an assumption that all non-taxed amounts are later recaptured (at ordinary income rates) when the MLP is sold. Is there any underlying reason why that isn't a reasonable assumption?


The ideal situation is to leave them to your heirs. They get a step in basis and owe no tax if they sell at that time.


Yes, that might be ideal if you have enough assets that you can be sure you will leave them to your heirs. But even then......you can never tax loss harvest.

If you have a dozen different MLPs in your portfolio, I don't see that being superior to a dozen individual stocks. You certainly will have superior diversification with individual stocks, since they won't all be in the energy infrastructure segment.

If your MLPs generate - for example - a 7% yield, you can do the same with stocks. The MLP investor pays tax on - for example - 20% of his distribution, so he pays 33% on 1.4%, for a tax burden of 0.46%. The stock investor gets a 2% dividend and pays 15% on that yield, for a tax burden of 0.3%. The get an equivalent cash distribution the stock investor now sells 5% of his shares, and he also has a 7% cash flow. If he has no built in capital gains, he pays 0% in tax burden.....and is superior to the MLP investor. If he has built-in capital gains of 25% (this is a VERY good outcome), his sales proceeds will be 20% gain. He pays 15% capital gains tax on the gain portion of the 5%. So he pays 15% on 1%, for a tax burden of 0.15%. The guy with the capital gain of 20% pays a total current tax burden of 0.45% while the MLP investor pays 0.46%.

On top of paying less in current tax, the stock investor can tax loss harvest any losers. This further widens his margin of victory. And he can also leave his highly appreciated stock to his heirs.

Best wishes.
Andy
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Postby indexfundfan » Mon Mar 14, 2011 3:03 pm

Whether MLPs are suitable tax-wise depends on personal circumstances.

When I retire, I expect that if I were to sell regular stock funds, the CG would be much higher than 25%. Since I tax-harvested heavily during the market lows, many of my stock fund holdings have CG of 50% or more.

Secondly, my marginal bracket would not be the 33%. I expect it to be lower.

Thirdly, it is unclear whether the 15% preferential rate for CG and qualified dividends would remain beyond the next two years. If they go back up, then the relatively advantage of stock fund qualified dividends disappears.

Nevertheless, MLPs would not be for everyone, especially if you hate to handle the additional K1 reporting.
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Postby Wagnerjb » Tue Mar 15, 2011 8:41 am

indexfundfan wrote:When I retire, I expect that if I were to sell regular stock funds, the CG would be much higher than 25%. Since I tax-harvested heavily during the market lows, many of my stock fund holdings have CG of 50% or more.



I am analyzing MLPs from the point of an investor with new money in a taxable account. If you have taxable funds that have a built-in capital gain, it is very hard to justify selling and purchasing another investment....and it isn't fair to burden MLPs or any other alternative in that manner. For the individual with new money considering investing in MLPs, the capital gains example is very realistic. If your total return is 7% per year and 5% is capital gain, it will be 5 years before you have a built-in gain of 25%. Under that scenario, it would be 10 years before the two competing investments are at break-even, with the stock investments winning until then.

Secondly, my marginal bracket would not be the 33%. I expect it to be lower.

Thirdly, it is unclear whether the 15% preferential rate for CG and qualified dividends would remain beyond the next two years. If they go back up, then the relatively advantage of stock fund qualified dividends disappears.


Yes, each of us has to evaluate the decision using our own tax rates. But it isn't hard to imagine a scenario that further widens the lead of individual stocks in this analysis. Marginal rates go to 39.6% and capital gains/dividends go to 20%.

The wild card in this analysis is tax loss harvesting. The guy who has tax loss harvested previously (with loss carryovers) can sell shares of his stocks for the additional 5% yield, paying zero tax. That puts him considerably ahead of the MLP investor.

Rob Arnott has published an excellent and thorough analysis of tax loss harvesting, and he demonstrates that the average annual benefit to the investor is in the 0.6% range. If the MLP guy cannot TLH without impairing his tax position, he is leaving an awful lot on the table.

http://www.firstquadrant.com/downloads/ ... esting.pdf

Best wishes.
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Postby btenny » Tue Mar 15, 2011 2:26 pm

MLP are very good stocks to own in retirement for their cash distributions. The key is many of us in retirement have pretty significant taxable portfolios that we want to hold for the long term so we need to decide how to invest those funds. We could buy tax free bonds and then live with the lower returns or we could buy regular corporate stocks but in both cases we would have to sell off bonds or stocks as we draw money during retirement as the returns are partly capital growth and fully taxable. Not so if we invest in MLPs, they throw off sufficient tax free returns to not need to sell your original investment during the withdrawal phase.

Thus converting some of your taxable money to MLPs during retirement makes a good trade off. We get tax free income from our taxable funds and we do not have to sell the taxable things as we get sufficint return to hold them long term....

Unfortunitely doing this with a large part of your portfolio is very risky (the single stock risk) so any MLPs you buy should be limited in amount. In my case I bought 2-3% way back when and have held it for 8 years or so. It has been a great investment. I plan to hold it for many more years.

I also did this with some Canadian oil trusts at the same time. These paid great dividends as well. But they have not worked out as well because Canada changed the laws on trusts without warning. I have not lost money because I held for the long term and with all the dividends I have made out OK but not as great as planned. So beware things can change.

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Postby pshonore » Tue Mar 15, 2011 8:03 pm

There are two problems with your idea. First, MLP distributions are tax deferred, not tax free. Second and more important, those distribtions reduce your basis as do the large operating losses reported by most MLPs. If you've owned them for 8 years there's a good chance your basis is approaching zero; particularly if you own some of the big depreciation generating MLPs like EPD and KMP. Once your basis reaches zero, distributions are taxed (as LTCG).

You're absolutely right about keeping these as a small part of your portfolio.
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Postby btenny » Wed Mar 16, 2011 2:01 pm

Well pshonore here are some facts to counter your opinion on MLPs. I have owned KMP for 8 years or so. I think it is a great investment and my tax bill to date is zero.

During my ownership period KMP stock has appreciated 70% versus what I paid for it. So if I were to sell today I would return 170% of what I paid. Plus I have also received about 70% in cash dividends during that time as well. So net net my returns to date are 280%. All tax free so far, yep not 5% taxes but ZERO taxes for all dividend income. I think this is a pretty good investment especially when you consider that the SP500 has returned about 9% in cap gains and maybe 25% in dividends.

Plus KMP is one of the better US companies. They are growing and investing in new pipelines and storage tanks and terminals every year. This growth is increasing the returns from my stock regularly and growing the dividends as well. To date my dividends have increased 170% since my initial purchase. I get $1.13 per share per quarter now versus $0.66 when I bought the stock. What mutual fund has done that well?

Now to your tax opinion. I have 57% capital loss carry over in my K1 account to date. The way I read this (I am not a tax accountant) if I were to sell I would pay some long term capital gains taxes on this amount. But since I have 43% to go I think I will keep the stock for few more years as the income is still tax free.

Plus cap gains taxes are the same as dividends taxes so net net I postponed paying taxes maybe 15-20 years at a minimum. I like that idea. Pay taxes with 50% depreciated dollars at a later date. Or even better maybe I postpone the tax forever if I give away the stock sometime in the future.

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Postby pshonore » Wed Mar 16, 2011 4:05 pm

Where did I say it was not a good investment?? I own several MLPs and in fact I think they are a good investment. My comment was you cannot collect distributions in some MLPs and expect them to be tax deferred forever and that they are not tax free investments. They are tax deferred. I'm not sure what you mean by a 57% loss carryover in your K1 Capital account but I will tell you that when you sell, a healthy portion of your gain is goimg to be taxed as Ordinary Income (which cannot be offset by Capital losses except for up to 3K that can be used to reduce any income.) This is because a lot of the depreciation that allowed the partnership to make tax deferred distributions gets recaptured as Ordinary Gain when you sell.
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Postby indexfundfan » Wed Mar 16, 2011 4:14 pm

Hi pshonore,

Just wanted to confirm what you have written in a prior post: when the cost basis reaches zero, are all distributions taxed as LTCG? Or am I reading it wrong?

If it is already taxed as LTCG, I assume they would not be recaptured if the holding is sold later?

Thanks.
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Postby fredflinstone » Wed Mar 16, 2011 6:42 pm

btenny wrote:I also did this with some Canadian oil trusts at the same time. These paid great dividends as well. But they have not worked out as well because Canada changed the laws on trusts without warning.


There's a lesson here for MLP investors: Don't assume that Congress will never change the laws governing MLPs.
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Postby fredflinstone » Wed Mar 16, 2011 6:42 pm

btenny wrote:I also did this with some Canadian oil trusts at the same time. These paid great dividends as well. But they have not worked out as well because Canada changed the laws on trusts without warning.


There's a lesson here for MLP investors: Don't assume that Congress will never change the laws governing MLPs.
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Postby Wagnerjb » Thu Mar 17, 2011 8:58 am

indexfundfan wrote:Just wanted to confirm what you have written in a prior post: when the cost basis reaches zero, are all distributions taxed as LTCG? Or am I reading it wrong?



That is what I have read....that any distributions in excess of basis are taxed as capital gains. Let me use a rather contrived example to demonstrate how this might play out. Assume you pay $10,000 to purchase the investment (MLP), and that it pays a 20% distribution ($2000) every year. For ease, let's assume there is no taxable income from the partnership, so you owe no taxes each year. After ten years you sell the investment for $10,000. I will use my personal tax rates (35% ordinary and 15% CG) to demonstrate the tax payments in this scenario. Feel free to use your own rates, tomorrow's rates, whatever....for your personal analysis.

Year 1: $0
Year 2: $0
Year 3: $0
Year 4: $0
Year 5: $0 (basis is now Zero)
Year 6: $300
Year 7: $300
Year 8: $300
Year 9: $300
Year 10: $300
Sale: $3,500

Now, compare the tax payments using the same facts, but assume you purchased an individual stock instead of an MLP (assume the company was profitable enough so that the dividend was qualified).

Year 1: $300
Year 2: $300
Year 3: $300
Year 4: $300
Year 5: $300
Year 6: $300
Year 7: $300
Year 8: $300
Year 9: $300
Year 10: $300
Sale: $0


Hope this helps.
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Postby indexfundfan » Thu Mar 17, 2011 10:42 am

Thanks for the illustration.
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Re: Publicly traded Master Limited Partnerships

Postby ricb » Fri Mar 15, 2013 11:03 pm

Anyone familiar with Miller Howard Investments? They're into MLPs and seem to think UBTI not a problem if MLP held in an IRA.
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Re: Publicly traded Master Limited Partnerships

Postby pshonore » Sat Mar 16, 2013 11:15 am

Most, MLPs don't produce positive UBTI on an annual basis. (UBTI generally equates to operating earnings which for most is a negative number because of copious amounts of depreciation). However there is some thought that when you sell, all that depreciation gets recaptured as Ordinary income which would be considered UBTI. If you have more than $1K of UBTI across ALL tax deferred accounts, your IRA Custodian is supposed to file a 990T return and pay the tax with funds from your IRA.

There are a few MLPs that do produce significant operating earnings which would be considered UBTI in a tax deferred account and for which a return should be filed.
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