How to Benefit From MLPs’ Complex Tax Rules / Investors have options when buying and selling master limited partnerships, a Morningstar expert explains

Janet Levaux for Think Advisor writes: Master limited partnerships are attractive total-return vehicles for investors, but their tax treatment can be intimidating.  ThinkAdvisor spoke with Abby Woodham, a fund analyst with Morningstar’s Passive Fund Research group in Chicago, about what issues investors should keep in mind when mulling MLP purchases and sales.

Can you briefly summarize the rather complex issue of MLP taxation?

Individual MLPs, which are partnerships and are not seen as separate from their owners, pass their tax liability onto unitholders, so you—the investor—would owe taxes on your portion of an MLP’s taxable income, which is stated on a K-1 tax form.

If your MLP investment generates high enough income in a state other than your own, you could have to file a tax return in that state. Luckily, some states (Texas, for instance) do not levy a state income tax.

This can be a bit of a pain for some people.

Can you explain what makes MLP taxation complicated?

The distributions you receive are treated as return of capital, and reduce your cost basis. You only pay tax on these distributions when you sell your MLPs units. This is effectively tax-differed distribution. Plus, you only pay taxes on the taxable part of a distribution, which often can be zero.

MLPs can use depreciation to reduce their reported net income lower than the level of cash they are distributing to unitholders. [snip]  The article continues at Think Advisor, click here to continue reading the article.