What are the disadvantages of MLPs?

What You Should Know About the Drawbacks of MLPs

Master Limited Partnerships (MLPs) have long attracted income-focused investors thanks to their high yield and tax advantages. But they’re not without downsides—and one of the most significant is how they’re treated in tax-deferred accounts like IRAs.

Normally, investments held within an IRA grow tax-free until withdrawal. However, MLPs generate income that the IRS often classifies as UBTI. When a significant amount of UBTI accumulates in an IRA, the IRA itself may become liable for taxes on that income. This defeats one of the core benefits of tax-advantaged accounts and can lead to unexpected tax bills.

For example, if you hold an MLP in your IRA and it generates more than $1,000 in UBTI annually, the IRA could owe taxes on the amount exceeding that threshold. This doesn’t happen with most stocks or ETFs, making MLPs a unique exception.

Additionally, MLPs distribute income through K-1 forms instead of standard 1099s, which can complicate tax filing. These forms often arrive later in tax season, increasing the chances of delays or errors. The structure also means investors may face state tax obligations in multiple jurisdictions, depending on where the MLP operates.

While the yields can be tempting, MLPs require more tax awareness than typical investments. Their complex reporting and potential for unexpected liabilities mean they aren’t a set-it-and-forget-it asset.

Because tax rules are nuanced and individual situations vary, it’s wise to consult a qualified tax professional before investing, especially within a retirement account. A little guidance now can save a lot of trouble at tax time.