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Tax implications of a publicly traded partnership investment

08/02/2017  |  By: Briana Mullenax, CPA, Shareholder, Wealth Advisors

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A publicly traded partnership can be an excellent investment choice, but as with most investment options, there are both benefits and possible complications for the investor. Here’s a look at what a publicly traded partnership is, some of its advantages and a few of the tax issues that you should be aware of.

What is a Publicly Traded Partnership?

A publicly traded partnership is any partnership that is either traded on an established securities market or readily tradeable on a secondary market. publicly traded partnership investments appear as a stock within a brokerage account but are taxed as a pass-through entity and issue a K-1 to investors. Sometimes the broker will include a separate list summarizing publicly traded partnership investments. A majority of publicly traded partnerships engage in oil, gas and other energy-related ventures.

Benefits of a Publicly Traded Partnership

One of the largest advantages of investing in a publicly traded partnership is that the partnership can avoid corporate tax treatment if 90 percent or more of the income is qualifying income. Qualifying income includes interest, dividends, rent from real property, gains from the sale of property and income from natural resources. This makes the income from the partnership subject to only one level of tax at the investor level, whereas, if this were a normal stock, it would be taxed at the corporation level and again at the investor level as a dividend.

Another advantage of investing in a publicly traded partnership is the liquidity of owning publicly traded stock. An investor in a publicly traded partnership has the benefit of selling interests very quickly through the market, if desired. When you sell your publicly traded partnership units, your taxable gain is the difference between the sales price and your adjusted basis. Cash distributions decrease and are commonly dispersed quarterly. Cash distributions from a publicly traded partnership are considered a return of capital and are not taxed as dividends at the federal level.

Complications of a Publicly Traded Partnership

Net losses attributable to an interest in a publicly traded partnership are not allowed to net against the investor’s other income. When a particular publicly traded partnership incurs a loss, that loss can only offset future earnings from that same publicly traded partnership. This is very different from interests in regular non- publicly traded partnership passive activities where allocated losses can be used to offset earnings for any other passive activity. These losses can only be realized upon either income recognition from the publicly traded partnership or a complete disposition of the publicly traded partnership units.

Complications can occur upon the sale of publicly traded partnership units. If publicly traded partnership units are sold at a gain, there is a division between taxing the gain at the preferential capital gain rate and the ordinary income rate. If publicly traded partnership units are sold at a loss, some of the loss may be disallowed depending on how much income has been recognized previously within that publicly traded partnership or how much of the publicly traded partnership units are disposed of. It should be noted that investment brokers rarely track shareholder basis for publicly traded partnership investments, but an adjusted basis will be shown on the Schedule K-1 when all or some of the units are sold. It gets especially complicated where there are publicly traded partnership units owned across multiple brokerage accounts. This will cause extra time for tax preparation to distinguish which units sold are coming from which accounts.

A publicly traded partnership may also operate in a number of states. Because a publicly traded partnership is a pass-through entity, the investor could be subject to filing tax returns and paying taxes in those states. These potential income taxes and additional tax return costs should be carefully considered when evaluating the economics of the publicly traded partnership.

Tax planning for publicly traded partnerships can be challenging because the income from publicly traded partnerships is often not estimated or communicated with investors before the Schedule K-1 release after year end. Additionally, if there is a sale of interest, the split between capital gain and ordinary income will be unknown since that is also provided as an attachment to the K-1.

While a publicly traded partnership can be a great investment, it pays to know how this type of investment might affect your tax bill. Be sure that you understand the tax issues regarding this investment option and consult with your tax advisor to assess how it will affect your personal situation.

Briana Mullenax is a partner with LBMC Wealth Advisors. She has experience in all areas of tax compliance and consulting services and now works primarily with high-wealth individuals and families and their related entities. Reach her at 615-309-2251 bmullenax@lbmc.com. Sabrina Greninger, a senior in the tax department, contributed to this article.