How are MLPs taxed when you sell them?

How MLPs Are Taxed When Sold

When you invest in Master Limited Partnerships (MLPs), the tax treatment can be quite different from traditional stocks—especially when it comes time to sell. While MLPs often provide generous distributions, many of these payments are considered a return of capital and are not taxed immediately. This is largely due to the significant depreciation and other tax deductions the MLP passes through to its investors.

However, the tax deferral comes with a catch. These deferred deductions reduce your cost basis in the MLP units. When you eventually sell, the IRS requires that part of your gain be “recaptured” and taxed as ordinary income rather than at the more favorable long-term capital gains rate. This recaptured portion typically corresponds to the cumulative depreciation deductions allocated to you during your holding period.

For example, if you received $20,000 in depreciation-related deductions over the years, that amount must be recaptured upon sale and is taxed at your regular income tax rate—even if your overall gain is much higher. The remainder of the gain may be treated as long-term capital gain, assuming you held the MLP for more than a year.

Additionally, MLPs generate a Schedule K-1 for tax reporting, which adds complexity to your tax return—often requiring state tax filings in states where the MLP operates. This can be a surprise for unsuspecting investors.

Because of these unique tax implications, selling an MLP can trigger a larger-than-expected tax bill, particularly on the ordinary income portion. Savvy investors often plan ahead, considering holding strategies or tax-loss harvesting to offset the impact. Given the complexity, consulting a tax professional familiar with MLPs is strongly advised before selling.