A master limited partnership, or MLP, is a publicly traded business that trades on a stock exchange like a corporation but is taxed like a partnership. You buy units on the NYSE or Nasdaq the same way you would buy shares, but the entity itself pays no federal income tax. Income, deductions, and gains pass through to you as a partner, and you report them on your personal return. Congress created the structure in the late 1980s to draw capital into energy and natural resources, and the tax code still restricts which businesses can use it.1Internal Revenue Code Section 7704
The appeal is straightforward: above-average cash distributions, most of them tax-deferred for years. The complications are just as real: a Schedule K-1 instead of a 1099, possible tax filings in multiple states, and a bigger tax bill than you might expect when you finally sell.
How an MLP Is Structured
Every MLP has two classes of owners. The general partner (GP) runs the business and typically holds about a 2 percent ownership stake. The limited partners (LPs) supply the capital by buying units on the open market. Trading feels identical to trading a stock, but the legal relationship is different. You are a partner, not a shareholder, and the IRS treats you that way.
Limited partners generally cannot vote on management decisions or board elections and have no say in daily operations. In exchange, your financial exposure is capped at what you invested. If the partnership takes on debt or gets sued, creditors cannot come after your other assets.
One protection you might assume you have, you probably don’t. Corporate directors owe shareholders fiduciary duties under state law. Most MLP partnership agreements explicitly eliminate those duties, and Delaware law, which governs most MLPs, permits that. The GP typically owes only an implied covenant of good faith and fair dealing, a much lower standard. Investors who expect the same protections they get as corporate shareholders can be surprised when a GP makes a self-interested decision that would never survive scrutiny in a corporate boardroom.
Which Businesses Can Be MLPs
Under Section 7704 of the Internal Revenue Code, a publicly traded partnership is taxed as a corporation unless at least 90 percent of its gross income each year comes from “qualifying” sources. The whole MLP structure lives inside that exception.1Internal Revenue Code Section 7704
Qualifying income centers on natural resources: exploring, producing, processing, refining, transporting, and marketing minerals, oil, natural gas, and timber. Midstream companies that run pipelines, storage terminals, and processing plants dominate the space because nearly all of their revenue qualifies. Interest, dividends, real estate rents, gains from selling real property, and certain commodity trading income also count.
For tax years beginning after December 31, 2025, the definition expands under the One Big Beautiful Bill Act. Newly qualifying activities include electricity generation from advanced nuclear facilities, hydropower and geothermal energy, carbon capture at facilities where at least 50 percent of carbon oxide output is captured, and the transportation or storage of hydrogen and certain renewable fuels. Solar and wind generation are not on the list.
Failing the 90 percent test in any year risks reclassification as a corporation, which would trigger entity-level tax and likely crush the unit price. That is why you don’t see MLPs outside energy, natural resources, and a handful of real estate and commodity businesses.
How You Are Taxed on Distributions
The core tax advantage is the absence of entity-level federal income tax. A corporation earns profits, pays the 21 percent corporate rate, and then shareholders pay tax again on dividends. MLPs skip the first layer. Every year you receive a Schedule K-1 reporting your share of the partnership’s taxable income, depreciation, depletion, and other items. You owe tax on your allocated share of income whether or not you received any cash.
In practice, the depreciation deductions MLPs generate usually offset most or all of the reported income, which is why a large portion of the cash you receive is tax-deferred. Distributions are usually paid quarterly, and most partnership agreements require the GP to pay out all available cash after operating expenses and maintenance capital.
A large portion of each distribution is typically classified as a return of capital rather than taxable income. Return-of-capital payments aren’t taxed when you receive them. They reduce your cost basis instead. Buy a unit for $50, receive $2 classified as return of capital, and your adjusted basis drops to $48. Over years of holding, basis can fall a long way.
Once your basis hits zero, further distributions are taxed as capital gains in the year you receive them. The deferral ends, and the cash becomes taxable even though you haven’t sold anything. Long-term holders sometimes reach this point without realizing it because they never tracked their basis. The K-1 supplemental schedules show the annual adjustments, and keeping those records matters more than most investors appreciate.
K-1 Timing
Partnerships must file by March 15, which leaves little time to send K-1s before the April 15 individual deadline. Most MLPs mail their K-1 packages in late March, and delays are common. If you own even one MLP, plan on filing a personal extension using Form 4868, which pushes your deadline to October 15. The extension gives you more time to file, not more time to pay. Any tax owed still has to be estimated and paid by April 15 to avoid interest.
What Happens When You Sell
Selling MLP units is more complicated than selling a stock. Your total gain is the sale price minus your adjusted basis, and years of return-of-capital distributions have likely pushed that basis down. A lower basis means a larger taxable gain, and not all of it qualifies for capital gains rates.
The depreciation deductions that reduced your taxable income each year come back at sale. Under Section 1245 of the tax code, the portion of your gain attributable to cumulative depreciation is taxed as ordinary income, not as a capital gain. If you claimed $10 per unit in depreciation over your holding period, that $10 is recaptured at ordinary rates when you sell. The remaining gain above the recapture amount is taxed at long-term capital gains rates if you held the units more than a year.
Section 751 adds another layer. If the MLP holds “hot assets” like unrealized receivables or substantially appreciated inventory, the portion of your sale proceeds tied to those assets is also taxed as ordinary income. Your K-1 for the year of sale will break out the recapture and any Section 751 amounts so you can report each piece correctly.
The upshot: MLP investors don’t avoid tax on distributions. They defer it, sometimes for many years, and then pay a mix of ordinary income and capital gains rates at sale.
The Inheritance Exception
One scenario where the deferred tax largely disappears is death. When an MLP unitholder dies, the heir generally receives a stepped-up basis equal to the fair market value on the date of death. Years of basis reductions from return-of-capital distributions and depreciation are wiped out. If the heir sells immediately, capital gains tax is minimal. This is one reason some long-term holders never sell.
MLPs in an IRA: The UBTI Problem
Holding MLP units in an IRA or other tax-deferred account looks like it would simplify things, but it creates a different problem. Because an MLP is a pass-through entity conducting an active trade or business, income it generates inside a tax-exempt account is classified as unrelated business taxable income (UBTI). If gross UBTI in a single IRA reaches $1,000 or more in a tax year, the IRA itself owes tax and must file Form 990-T.
The first $1,000 of gross UBTI per IRA is exempt, and the threshold is measured per account, not per investment. If you hold three MLPs in one IRA and their combined UBTI hits $1,000, a filing is required. The IRA custodian typically prepares Form 990-T, but the tax is paid from the IRA’s assets, which reduces your retirement balance. UBTI above the exemption is taxed at trust rates, which reach the top bracket at a relatively low income level.
Investors who want MLP exposure without the UBTI issue often use exchange-traded funds and mutual funds that hold MLP units. These funds are structured as C corporations. They pay entity-level tax, which reduces returns, but investors receive a standard 1099 and never see a K-1.
State Tax Filings You Might Not Expect
MLPs operating pipelines, terminals, and processing plants in multiple states allocate income to each state where they do business. As a limited partner, you may owe state income tax in every one of those states, whether or not you have ever set foot there. Your K-1 supplemental information usually includes a state-by-state income breakdown.
Filing thresholds vary. Some states require a nonresident return if even a single dollar of income is allocated there. Others set a minimum before a return is required, and nine states have no individual income tax at all. A large pipeline MLP can operate in 20 or more states, and the filing burden gets expensive fast. Reviewing the K-1 supplemental schedules before you buy gives you a realistic sense of how many state returns to expect.