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Author: OSUMAG Two stars, 250 posts Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121096  
Subject: Re: MLPs in IRAs Date: 8/9/2010 9:21 PM
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Rob,

I performed a quick search on CCH to see if there were any good tax strategies you may take with owning a MLP in an IRA. I did not find anything on point, but I did come across the following article, Energy-Related Master Limited Partnerships Present Investment Opportunities with Some Tax Complexity, (Apr. 1, 2004) by Richard B. Toolson, Ph.D., CPA in CCH’s TAXES – The Tax Magazine (I know, just as exciting as Us Weekly)

The article goes over the basics of owning a MLP and its advantages such as generous cash distributions and low price volatility. Toolson does recommend holding a MLP in a taxable account. However, I am attaching a section describing a possible solution. It might help if you do some hop-scotching with your various MLP investments. In other words, hold for a year, wait for the last quarterly distribution, sell, buy another MLP, and so on. You can buy the same MLP every other year. Since you own the MLP in an IRA, you do not need to worry about any depreciation recapture or capital gains on the disposition.

Emphasis added. Ignore references to the tax code.

Normally, MLPs make an election under Code Sec. 754, which allows an adjustment to the inside basis of partnership property equal to the difference between the partner's outside basis (generally the purchase price plus share of liabilities) and the partner's proportionate share of inside basis. 22 If the outside basis exceeds the partner's share of inside basis, an upward adjustment would be made to the partner's share of partnership property. 23 By the same token, if the outside basis is less than inside basis, a downward adjustment would be made to the partner's share of partnership property. 24 Code Sec. 755 prescribes the process for allocating the adjustment among the various partnership assets, including depreciable properties. This inside basis adjustment for partnerships extends to MLPs. As a result, assuming a Code Sec. 754
election is in place, the unit holder's share of depreciation deductions will be based on the fair market value of the depreciable property at the time the MLP is purchased and not on the partnership's adjusted basis in the property. Because tax depreciation rates normally will exceed the economic depreciation rates for MLP depreciable assets, new unit holders usually will receive a greater depreciation deduction than older unit holders. Typically, as the unit holder's holding period increases and less depreciation is passed through to the unit holder, less of the unit holder's cash flow will be shielded from taxation. At that point, the investor may want to consider selling the old MLP and reinvesting the proceeds in a new MLP that will be able to shield more of the cash flow from taxable income. Alternatively, if the investor wants to retain ownership in the original MLP, the investor might purchase additional units in order to receive a step-up in basis in the partner's proportionate share of depreciable property on the new units, with the result that a greater percentage of cash flow will be shielded from taxation.


Some food for thought… I cannot verify if it this strategy will work, but it may help reduce the likelihood of getting a big hit of UBTI. Please take my tax advice with a grain of salt.

As discussed in the previous post, I am worried about all the tax depreciation taken this past decade (primarily from bonus depreciation), so I expect higher taxable income and UBTI this decade. However, if the MLP is aggressively adding PP&E, the tax depreciation can still potentially be greater than book depreciation which should limit the taxable income. Of course, aggressive asset additions would subsequently reduce potential distributions to the partners.

Unfortunately, an investor cannot obtain adequate disclosure in the 10-K on potential deferred tax liabilities such as the difference in the book/tax basis of PP&E. For example, Magellan Midstream Partners, L.P. had approx. $500 million in net PP&E additions in 2009 (including acquisitions of businesses). Through the first half of 2010, they only have $100 million in net PP&E additions. Without bonus depreciation in 2010, they will not have the significant taxable losses as in the past, but they potentially may have enough tax depreciation to exceed book depreciation, which may keep taxable income low.

Good luck!
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