For informational purposes only – consult a tax advisor
In addition to benefiting from pass-through taxation, MLP investors also enjoy a deferral of taxes on the majority of cash distributions paid to them (approximately 90%). The deferred amount is then subtracted from the LP unitholders’ cost basis and is not realized until the unit is sold.
For example, if a unitholder receives $1 in distributions on a unit they paid $20 for in a given year, only $0.10 is considered regular taxable income. The remaining $0.90 is subtracted from the original unit cost basis to get the adjusted basis, and taxes are not paid until the unit is actually sold (at the time of sale, tax is paid on the difference between cost basis and adjusted basis). An example using an initial yield of 5% and assuming an 8% growth in cash distributions is shown below.
Example of Tax Deferral
In addition, the taxable gain of $8.87 when the unit is sold in Year 2 is taxed at 2 different rates. The gain on the difference between the sale price and the initial cost ($27 – $20 = $7.00) is taxed at the capital gains rate. However, the $1.87 balance is taxed as ordinary income.