The problems with master limited partnerships start with a Schedule K-1 that shows up late every spring and end with a tax bill at sale that can swallow years of distributions. In between sit multi-state filing obligations, basis tracking that your broker won’t do for you, a retirement-account trap called UBTI, forced concentration in midstream energy, and a governance model that lets the general partner tilt decisions in its own favor. The quarterly yield is real. So are the costs of collecting it.
K-1s Arrive Late and Complicate Your Return
MLP investors do not get a Form 1099-DIV. They get a Schedule K-1 (Form 1065) that breaks down each unitholder’s share of the partnership’s income, deductions, and credits.1Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065) A 1099 lands in January or early February. K-1s routinely arrive in March or April, because the partnership itself has until March 15 to file (September 15 if it extends), and individual K-1s follow from there.
That timing problem compounds across positions. If you own units in three MLPs and one is late, your entire personal return waits. Many MLP investors simply file an extension every year as a matter of course. The K-1 is also far more complex than a 1099, with dozens of boxes covering ordinary business income, Section 179 deductions, foreign tax credits, and more. Entering a box in the wrong field is easy. Catching the mistake later is expensive.
You May Owe Taxes in States You’ve Never Visited
A single MLP can operate pipelines, terminals, and processing plants across a dozen states. Partnership income passes through to unitholders at the state level too, so you may owe nonresident income tax in every state where the MLP earns money. That means filing nonresident returns in states where you’ve never set foot, each with its own forms, deadlines, and rules.
Thresholds vary. Some states require a nonresident filing for any amount of income earned there; others set thresholds ranging from a few hundred to several thousand dollars. Nine states have no individual income tax, which drops them out of the equation. The practical result for a single MLP position can be three, five, or ten extra state returns, each one potentially requiring a preparer who knows that state’s rules. The preparation fees alone can eat into the yield that drew you to the units.
Your Broker Won’t Track Your Basis
Your cost basis in MLP units gets adjusted every year you hold them. Income allocations push it up. Losses, deductions, and distributions pull it down. Most MLP distributions are classified as a return of capital rather than taxable income, which sounds like a benefit, but those distributions chip away at your basis year after year.
The key point: your brokerage firm is not responsible for tracking your adjusted basis. That job is yours. Each year’s K-1 provides the pieces; assembling them into an accurate running tally over a long holding period is on you. Many partnerships offer online portals where you can download K-1 data and historical allocations, which helps. If you sell after a decade and can’t reconstruct the adjustments, the tax consequences can be severe. Your broker will report the sale on Form 1099-B using your original purchase price, which will almost certainly be wrong because it ignores every adjustment since the day you bought in.
The Tax Bill When You Sell
This is where the deferred tax advantages come back to collect. Years of tax-sheltered distributions and depreciation deductions create a reckoning at sale that surprises investors who focused only on the quarterly checks.
Return of Capital Shrinks Your Basis
Return-of-capital distributions reduce your tax basis but cannot push it below zero.2eCFR. 26 CFR 1.705-1 – Determination of Basis of Partner’s Interest Once your basis hits zero, any further cash distributions trigger immediate taxable gain, treated as proceeds from selling part of your partnership interest.3Office of the Law Revision Counsel. 26 USC 731 – Extent of Recognition of Gain or Loss on Distribution
A simple example makes it concrete. You buy a unit for $20. Over several years, you receive $15 in return-of-capital distributions, dropping your adjusted basis to $5. You sell for $25. Your economic profit is $5 (you put in $20 and got back $40 total). But your taxable gain is $20: the $25 sale price minus your $5 adjusted basis. And a chunk of that $20 gain won’t qualify for capital gains rates at all.
Depreciation Recapture at Ordinary Rates
When you sell MLP units, the gain attributable to the partnership’s depreciation deductions passed through to you over the years gets reclassified as ordinary income under Section 751.4Office of the Law Revision Counsel. 26 USC 751 – Unrealized Receivables and Inventory Items Those deductions reduced your taxable income while you held the units, and the IRS wants them back at ordinary rates when you exit.
Only the remaining portion of the gain qualifies for long-term capital gains treatment. The partnership’s final K-1 for the year of sale tells you the split between ordinary and capital components, and you need that document to file correctly. The broker’s 1099-B cannot make the distinction, so investors who rely on it alone will misreport.
UBTI Makes MLPs a Problem Inside Retirement Accounts
Holding MLP units inside an IRA, 401(k), or other tax-exempt account creates a problem most investors don’t see coming. MLPs generate income from an active trade or business, and when that income flows into a tax-exempt account it becomes Unrelated Business Taxable Income. If your IRA’s UBTI from all sources exceeds $1,000 in a tax year, the account must file Form 990-T and pay tax on the excess.5Internal Revenue Service. Unrelated Business Income Tax
The rate is worse than many investors expect. IRAs pay UBTI at trust tax rates, not individual or corporate rates.6Office of the Law Revision Counsel. 26 USC 511 – Imposition of Tax on Unrelated Business Income Trust brackets are compressed. For 2025, the 37% top rate kicks in at just $15,650 of taxable income.7Internal Revenue Service. Instructions for Form 990-T Modest UBTI gets taxed at the highest marginal rate far faster than it would on your personal return. Add the cost of filing a separate return for your IRA, and most advisors steer clients away from direct MLP ownership inside retirement accounts.
Sector Concentration You Can’t Diversify Away
To keep partnership tax treatment, an MLP must earn at least 90% of its gross income from qualifying sources. The statute defines qualifying income primarily as revenue from natural resource activities: exploration, production, transportation, processing, refining, and storage of minerals, oil, and gas.8Office of the Law Revision Counsel. 26 USC 7704 – Certain Publicly Traded Partnerships Treated as Corporations Interest, dividends, real property rents, and certain renewable energy activities also qualify, but the overwhelming majority of MLPs cluster in midstream energy: pipelines, terminals, and processing plants.
MLPs cannot meaningfully diversify into unrelated businesses without putting their tax status at risk. When energy prices collapsed in 2014–2016, the entire MLP asset class fell together. An investor who thought they held a diversified MLP portfolio actually held concentrated exposure to a single sector.
Growth is structurally difficult too. MLPs distribute most of their cash flow to unitholders, leaving little for reinvestment. Expansion requires issuing new units (diluting existing investors) or taking on debt. The model works well in a low-rate, rising-energy environment and struggles in almost every other scenario.
Governance Tilts Toward the General Partner
The general partner typically controls operational and strategic decisions while holding a small equity stake. That gap between control and economic exposure creates misaligned incentives from the start. MLP partnership agreements usually define fiduciary duties far more narrowly than corporate law does. The GP can often take actions that benefit itself at the expense of limited partners, provided those actions don’t violate specific terms of the agreement. In corporate governance, directors must act in shareholders’ best interest. The MLP bar is considerably lower.
Incentive Distribution Rights
Incentive Distribution Rights are the clearest expression of this misalignment. IDRs give the general partner an escalating share of distributable cash flow once quarterly distributions to limited partners cross certain thresholds. The structure is tiered, and at the highest tier the GP can capture up to 50% of every incremental dollar distributed.
The incentive is obvious. The GP benefits from pushing distributions higher, which encourages aggressive acquisitions funded by new equity and debt. Limited partners carry the risk of overleveraging and overpaying, while the GP collects its escalating cut. IDRs also raise the partnership’s cost of equity over time, since every new dollar of cash flow carries a heavier GP take, making growth progressively harder to deliver to the limited partners who funded it.
Related-Party Transactions and Weak Voting Rights
The GP frequently transacts with affiliated entities it also controls, buying services or assets at prices the GP itself sets. These deals are disclosed in public filings, but limited partners have almost no practical ability to challenge pricing or block a transaction. Voting rights for limited partners are typically restricted to extraordinary matters like removing the GP for cause, and that threshold is usually designed to be nearly unreachable.
Foreign Investors Face Heavy Withholding
Non-U.S. investors face an additional layer of friction. MLP income allocated to a foreign partner is treated as effectively connected with a U.S. trade or business, which triggers mandatory withholding. The partnership withholds at the highest applicable rate: 37% for individual foreign partners and 21% for corporate foreign partners on their allocable share of effectively connected taxable income.9Internal Revenue Service. Partnership Withholding
When a foreign investor sells MLP units, Section 1446(f) requires the buyer or broker to withhold 10% of the total amount realized on the sale.10Office of the Law Revision Counsel. 26 USC 1446 – Withholding of Tax on Foreign Partners’ Share The foreign investor must then file a U.S. return to report the income and claim any refund of overwithholding.
What Offsets the Pain: 199A and the Step-Up at Death
Two features cut against the complexity. MLP investors can claim a 20% deduction on qualified publicly traded partnership income under Section 199A.11Internal Revenue Service. Qualified Business Income Deduction Originally set to expire after 2025, the deduction was made permanent by the One Big Beautiful Bill Act signed in July 2025. For a top-bracket investor, a 20% deduction on MLP income effectively lowers the rate on that income to about 29.6%. Unlike the QBI deduction for other pass-through entities, the PTP version is not limited by W-2 wages or capital invested in the business.
The second feature kicks in at death. When a unitholder dies, the heir receives a stepped-up basis equal to the fair market value of the units on the date of death. That step-up effectively erases the accumulated deferred tax liability, including the return-of-capital reductions and depreciation recapture that would have hit the original holder at sale. For long-term holders in estate-planning mode, the deferred tax bomb becomes a feature: the longer you hold and the more distributions reduce your basis, the larger the liability that disappears at death. Some investors hold MLPs specifically with that outcome in mind.
Fund Alternatives if You Want the Yield Without the K-1
Two fund structures let you reach energy infrastructure without the direct MLP paperwork, and each comes with a cost.
Funds structured as C-corporations can hold 90–100% MLPs and issue shareholders a standard Form 1099-DIV. No K-1, no multi-state filing, no UBTI concerns in a retirement account. The price is a corporate-level tax on the fund’s income and unrealized gains. The fund accrues a deferred tax liability at the 21% federal corporate rate plus state taxes, which drags on returns. In a rising market, a C-corp MLP ETF will meaningfully underperform the underlying MLP index.
Regulated investment companies (most mutual funds and ETFs) can hold MLPs but cap them at 25% of fund assets. These funds pass through income without corporate-level tax but offer diluted MLP exposure mixed with other energy equities. Investors in C-corp MLP funds also lose the Section 199A deduction, since income arrives as a corporate dividend rather than qualified PTP income. The simpler the wrapper, the more tax drag or dilution comes with it. Direct ownership still produces better after-tax results for the right holder, particularly one planning around the step-up at death.