John D. Thomason

Value, contrarian, special situations
John D. Thomason
Value, contrarian, special situations
Contributor since: 2011
No - neither position re-establishes the holding that existed from the losses taken. The short sale concept is a loss is disallowed if the investor (or spouse, if married) effectively re-establishes the position within 30 days (in either direction) of the holding that was given up at a loss. In such a case, the IRS position is that a loss in that case is not "real", since the investor re-established his position, so the only reason to have taken the loss was for tax purposes.
John D. Thomason
Capital Gains are reported immediately. See Partner's Instructions for Schedule K-1 (Form 1065). The passive items must be tracked separately, as stated in the article, depending upon whether they would be reported on Schedule E or form 4797 if and when they can be reported. The details of this process is (supposedly) explained in the instructions for Form 8582, Passive Activity Loss Limitations. See the section headlined Publicly Traded Partnerships (PTPs), on page 12 of my copy. (2013 edition, but this hasn't changed.) Note that the form 8582 is not used for PTPs and is never filed with the IRS for PTPs, because their activity cannot be combined with activity from other PTPs or non-PTPs, but the worksheets 5, 6, and 7 are suggested for use by the taxpayer to track the accumulations required. You would need a set of the worksheets for each PTP, for each year you own them. I had the advantage of observing exactly how the software handles the PTP activity, which helped me to finally grasp it. The software effectively does just what the instructions suggest, maintains files equivalent to the Form 8582 worksheets 5, 6, and 7. It hold the suspended losses, where they are then used the next year, where the determination is made, after adding in the new year's activity, whether the losses can be used, or the updated values suspended for another year. The Form 8582 Instructions and Publication 925, Passive Activity and At Risk Rules, and the K-1 instructions mentioned earlier are where you will find the information to piece this puzzle together. You are not alone in finding this all very confusing. I was able to experiment with the software and observe the effects of various combinations on the forms generated and the suspended losses held in the tables, which allowed me to see what goes on.
John D. Thomason
John D Thomason
Hi, WmHilger1,
Thanks much for the kind words. As always when I put out an article, I learned a few things as well from reader's comments. Right now I'm swamped with other endeavors, but later on I plan to follow up on some of the questions raised by readers, one being transfers of MLP units from an IRA to a regular account. I was surprised this was even possible. Incidentally, what I'm swamped with is studying for an IRS Certification exam. I have as my goal to continue to advance as a tax preparer, focusing on investment topics. As I continue to read and study, in the back of my mind, I'm thinking "if I ever really understand this stuff, I hope to heck I can explain it better than what I'm reading". The jury is still out, but be advised I am working on it, we'll see if I can live up to that goal.
Thanks again.
John D. Thomason
No. When distributions are received and basis is zero, they are considered capital gains, as you note. There is no further impact from the distributions thus reported.
John D. Thomason
Hi, usiah,
I'm not sure this would even be allowed, and the only part I am pretty sure of is it would be a taxable distribution from the IRA, subject to penalty if no exception applies, such as participant over age 59 1/2. I can only guess that it would be valued as of the closing price on the transfer date. Considering all that goes into determining basis for an MLP in a taxable account, I cannot fathom how such a transfer would be treated once in the regular account. I would be surprised that an IRA custodian would make such a transfer, I would think the MLP units would have to be sold inside the IRA, and then the proceeds withdrawn or transferred as cash. If the custodian makes such a transfer, I would say look to them for direction on how to handle it. Sorry, I'm not much help here - this situation is definitely not covered any "MLP Owner's Manual" that I have seen. Maybe someone in the SA readership can provide information.
John D Thomason
Hi, jaymarx,
Determining when basis has gone to zero and thus reporting distributions in excess of basis is best facilitated by the partner calculating basis annually from the K-1 instead of depending on the partnership's sales schedule. That way, the partner will be aware when basis has declined enough to make distributions potentially reportable. See the article section on sequencing of adjustments to basis. Following those steps, one will see what the basis is just before considering the year's distributions' adjustment to basis, and thus the extent that distributions for that year exceeds basis can be determined.
John D. Thomason
Hi, gup1936,
I'm not sure what you're asking, but both passive and non-passive income, losses, and expenses affect basis as they occur each year, as indicated on the K-1 Part 3 boxes 1 through 20. As far as net passive losses are concerned, they are suspended, and are not reported currently on Schedule E / Form 4797, but they do reduce basis. That is, the fact that the losses are suspended from being reported currently does not mean they don't reduce basis as they occur.
John D. Thomason
Hi, GD,
I had written an article on this topic that came out at about the same time as the Reel Ken article referenced above. Go to my list of articles at my SA Profile to see it. My initial view, as expressed in my article, was that for small investors, the likelihood of exceeding $1000 of UBTI in an IRA was minimal, and worth the risk. While I still more or less subscribe to that view, after digesting (as best I could) Reel Ken's article and the many comments, I later updated my article via Seeking Alpha's corrections policy to reference the Reel Ken article, and conceded that he made a valid point. The key issue is whether or not the sale of MLP units inside an IRA could trigger a significant release of UBTI, which could put even a small investor over the $1000 threshhold. I believe it could, but in is unclear just how this would become known to the IRS. Presently, the UBTI reported in K-1 Box 20 Code V only seems to be UBTI from continuing operations, which would be unlikely to exceed $1000 for a small investor. It seems to me that at this time, UBTI generated by a sale of units, if indeed UBTI is generated by the sale event, is not being reported on the K-1, nor elsewhere, to either the partner nor the IRS. But I cannot say that this will not be the case in the future - in fact, I cannot say with certainty that it is not available to the IRS currently, being at least derivable from the sales schedule. The IRS is on an ongoing quest to increase accountability and tax collections from all sources, especially investors, as evidenced by the introduction of Form 8949 and new basis reporting requirements, beginning in 2011. It is entirely possible that Reel Ken's view is correct, that sale of units inside an IRA should result in significant UBTI being generated, and that this will be required to be reported explicitly in the future to the partner and the IRS when units are sold, probably on the K-1. Also, right now, reporting sales of MLP units properly in regular (non-IRA) accounts, including the ordinary income component from depreciation recapture, is frequently mishandled, especially by small investors attempting to do their own taxes. The IRS may someday tighten up reporting and enforcement significantly for PTPs, both in IRAs and regular accounts, with much better integration between the partnerships and brokerages being required to properly report basis and income resulting from sales. Holders of significant positions in MLPs in IRAs are betting this won't happen. My view of this is like everything else related to investing - anything is possible! One cannot count on the future always being just like the past - things can change.
John D Thomason
Hi, KCN,
I finally came out with an article on MLPs and K-1s. I have come a long way as a tax preparer in the past two years. I had not seen any comment from you on the new article, but be assured your encouragement was a factor in motivating me to write it!
John D. Thomason
Yes, the prospectus verbiage which states "we anticipate accruing and making the guaranteed payment distributions monthly." says it all - the payments are only guaranteed to be paid if all goes well. Elsewhere, it is clearly stated that the preferreds are senior to the regular partnership units but are subordinate to debt holders. But to answer the basic question Grant18m had, it is clear from the prospectus that the income from the preferreds is not like partner distributions, but rather is reportable immediately as ordinary income, and does not reduce basis, and that upon sale of the preferreds, there would be no ordinary income from recapture of depreciation, amortization, or depletion. Just getting confirmation of those particulars from the prospectus provides some relief from anxiety of how to handle from a tax perspective.
John D Thomason
Hi, marooned,
Distributions are not normally reported; they reduce basis, and thus a recovery of sorts occurs when you sell, since you will have a larger gain to report at that time. An exception to the preceding is if the units have been held for some time and basis goes to zero, any distributions in excess of basis are reported, as capital gains. The "informational filing" characterization of the K-1 is incorrect. Any "portfolio income" items are reported immediately on the tax return. An example would be interest from Box 5 of the K-1, or dividends from boxes 6a and / or 6b. Net positive passive income is reportable currently as well. I lay all this out in the article in the best English I can muster. I suggest you present the article to your tax preparer, and if he says he doesn't understand it, find a new tax preparer.
John D Thomason
Only if the payment was for services. The payment is for capital. I really don't agree with the position that the LLC has taken, treating the preferred holder as a limited partner and reporting what is essentially preferred stock dividends as "guaranteed payments", but as long as the recipient treats the monies received as ordinary, taxable income, I don't see any problem for the recipient.
This is definitely an odd situation.
John D Thomason
Update on Situation Brought Up by Grant18m,
After receiving some info from reader Grant18m, I was able to find out more about this case, and I responded to him separately. In the interest of sharing knowledge gained to all, here is what was learned:
The MLP is an LLC that has selected partnership taxation, VNR. The LLC has preferreds associated with it, VNRPB. After Grant18m shared this info, I was able to go to my favorite resource for preferreds, Quantumonline, an excellent resource for preferreds:
http://bit.ly/T5zbpY
The VNRBP has the info on tax treatment in the prospectus, which Quantum provides a link to. To get there:
Once at the Quantum Home Page, Type in VNR, then select “Find All related Securities for VNR”, then select VNRBP.
The Description has the following statement imbedded:
“Holders of Series B Preferred Units will receive specific tax information from the company, including a Schedule K-1 which generally would be expected to provide a single income item equal to the preferred return.”
Then below the description, click on “Link to IPO Prospectus”
Deep down in that document, there is a section on Tax Treatment for the Series B Preferreds, which sheds some light on what the holders can expect:
“Treatment of distributions on our Series B Preferred Units as guaranteed payments for the use of capital creates a different tax treatment for the holders of our Series B Preferred Units than the holders of our common units.
The tax treatment of distributions on our Series B Preferred Units is uncertain. We will treat the holders of Series B Preferred Units as partners for tax purposes and will treat distributions on the Series B Preferred Units as guaranteed payments for the use of capital that will generally be taxable to the holders of Series B Preferred Units as ordinary income. Although a holder of Series B Preferred Units could recognize taxable income from the accrual of such a guaranteed payment even in the absence of a contemporaneous distribution, we anticipate accruing and making the guaranteed payment distributions monthly. Otherwise, the holders of Series B Preferred Units are generally not anticipated to share in our items of income, gain, loss or deduction. Nor will we allocate any share of our nonrecourse liabilities to the holders of Series B Preferred Units. If the Series B Preferred Units were treated as indebtedness for tax purposes, rather than as guaranteed payments for the use of capital, distributions likely would be treated as payments of interest by us to the holders of Series B Preferred Units.
A holder of Series B Preferred Units will be required to recognize gain or loss on a sale of units equal to the difference between the unitholder’s amount realized and tax basis in the units sold. The amount realized generally will equal the sum of the cash and the fair market value of other property such holder receives in exchange for such Series B Preferred Units. Subject to general rules requiring a blended basis among multiple partnership interests, [JT Note: I believe this means as long as no regular units in the LLC are owned, the basis of the Preferreds does not change. End JT Note] the tax basis of a Series B Preferred Unit will generally be equal to the sum of the cash and the fair market value of other property paid by the unitholder to acquire such Series B Preferred Unit. Gain or loss recognized by a unitholder on the sale or exchange of a Series B Preferred Unit held for more than one year generally will be taxable as long-term capital gain or loss. Because holders of Series B Preferred Units will not be allocated a share of our items of depreciation, depletion or amortization, it is not anticipated that such holders would be required to recharacterize any portion of their gain as ordinary income as a result of the recapture rules.”
Thus, the K-1 is just a convenient way for the VNR to report the income to the holder of the preferred units. For all other purposes, the preferreds are treated the same as any other preferred. I believe the “guaranteed payments” is non-passive income, and reportable the same as any other preferred, as dividend income, not qualified dividends. An alternative would be to report the income on Schedule E as nonpassive income. The tax consequence will be the same either way, with the income being reported as ordinary income on the 1040. The basis is not affected by the income received, it is handled the same as any other preferred, it remains the initial cost. Gain / loss upon sale is calculated the same as any other preferred, it is the net proceeds minus the purchase cost.
I believe this unravels the mystery. It was quite a curve-ball. I keep thinking I've seen it all on MLPs, and I keep finding out that "wait, there's more"!
John D Thomason
It looks like you did well. WPZ has pulled back since then. Yes, I couldn't help but notice that whereas I had 100 units of WPZ before the ACMP merger, I only had 86 units afterwards, trading at about the same price. It escapes me how that deal could have been viewed so positively, as touted in the press releases.
It looks like WMB is copying the KMI strategy. I own WPZ. It looks like a win-win at this point - take the money & run or hold on for dividends to come. Tough decision.
John D Thomason
Hi, Philipsonh,
Even so, it is helpful to the CPA if the client knows a little about the challenges of MLPs, and keeps all K-1s and "tax packages" received, making them available to the CPA. Not to mention refraining from creating nightmare tax situations, such as frequently trading in and out of positions in these entities.
John D Thomason
The reference refers to the ability of a taxpayer to deduct up to $25000 of rental losses on rental property "with active participation" by the taxpayer from other income, which begins to phase out as modified AGI exceeds $100,000, and is eliminated entirely if it exceeds $150,000. Rental losses on properties for which the taxpayer has no "active participation" are not eligible for the (up to) $25000 deduction against other income, so it is moot in that case.
John D Thomason
Update on Corrections,
The errors referred to, which all concerned references to Schedule E Columns, have been fixed. Thanks & kudos to the SA Editorial team for their quick response to my somewhat nitpicky corrections!
Hi, rip2451,
Thanks for the additional info. To be honest, I just copied the referenced article's comment on donating MLP units to charity, and had not researched it. Your clarification explains it much more clearly.
John D Thomason
Hi, Mr. McCammon,
Copied following is my response to Steve021, above, who brought up this subject plus a couple of related questions:
In researching your questions, I came across an excellent article from Cumberland Advisors that addresses your questions. The link is: http://bit.ly/1FfNd3X

A couple of snippets from the article are:

What happens to an estate that holds MLPs and has to determine the amount of estate taxes paid on the value of the estate? Similarly to other investments, the cost basis in an MLP will be reset (or stepped up) to the current market value when the investment is passed on to an heir upon the unit holder’s death. The stepped-up value will be included in the decedent’s estate and may be subject to estate tax, based on the current market value of the investment, just as with other investments. However, because of the potential for tax deferral on MLP distributions, the distributions received during the deceased unit holder’s life may never be taxed.
This would be one way to beat the tax man - but it is not my preference!
Hope this helps.
John D Thomason
I had this same question, and the tax authority I was able to consult through my employer clarified it for me. The ordinary income from depreciation recapture is always reported as income on Form 4797, and will be positive. But if there is no gain, but instead there is a loss, based on the sales proceeds and the adjusted basis, then the reported loss will be that loss, plus the loss will be further increased by the ordinary gain reported. Likewise, if there was only a minimal initial gain, but it is outweighed by the ordinary gain reported, the loss will be equivalent to the ordinary gain, less the minimal initial gain.
John D Thomason
Hi, mc2406,
There is a long list of possibilities for box 20, identified in the IRS "Partner's Instructions for Schedule K-1", codes A through Z. Most of the possibilities would not affect passive income/loss, basis, or at risk, I cannot say for sure that no box 20 items can ever affect them. For example, I think code T, depletion, would affect basis, if a deduction is taken. Some of the more common box 20 items are:
Code A, Investment Income. Report on Form 4952, Line 4a.
Code B, Investment Expenses. Report on Form 4952, Line 5.
Code T, Depletion. A statement will be provided. Refer to the partner’s instructions and Publication 535 to determine if a depletion deduction can be taken. Any depletion deduction taken will decrease basis, I would think.
Code V, Unrelated Business Taxable Income (UBTI). Only applies if the PTP is held in a retirement account, such as an IRA. If the total of the UBTI of all PTPs in the account exceeds $1000, the account custodian is required to file form 990T, and pay tax on the excess UBTI. The tax paid will be deducted from the IRA holder’s account. Some custodians will charge a fee for filing the 990T, which will also be deducted from the IRA holder’s account.
Code Y, Net Investment Income. This code may be used to provide the partner with information needed to determine Net Investment Income Tax, per Form 8960.
John D Thomason
Hi, Marooned & April May,
I have considered this, and I will likely follow through, but not soon. To do justice, the article would need to reference completed tax forms, and could be quite lengthy. It would be a challenge to to present properly on SA, since it would exceed their preferred length maximums - which seems to be par for most articles I have submitted. But certainly, nothing clarifies a topic like this better than an actual example.
John D Thomason
Hi, Steve021,
In researching your questions, I came across an excellent article from Cumberland Advisors that addresses your questions. The link is: http://bit.ly/1FfNd3X
A couple of snippets from the article are:
What happens to an estate that holds MLPs and has to determine the amount of estate taxes paid on the value of the estate? Similarly to other investments, the cost basis in an MLP will be reset (or stepped up) to the current market value when the investment is passed on to an heir upon the unit holder’s death. The stepped-up value will be included in the decedent’s estate and may be subject to estate tax, based on the current market value of the investment, just as with other investments. However, because of the potential for tax deferral on MLP distributions, the distributions received during the deceased unit holder’s life may never be taxed.
Don’t donate depleted MLPs to charity. Since they have been embedded with unrecognized ordinary income, your deduction would be limited to the stock market appreciation in the shares.
Plus, though not from the article, I would say do not "gift" units of an MLP to someone - unless it's an obnoxious relative that you want to punish, along with yourself - there is no step-up of basis for gifts - the basis for the recipient is the basis of the donor at the point of the gift. The donor is required to pay any gift tax due and file a gift tax return, if the value exceeds a certain amount, and the recipient would need to deal with all of the subsequent tax issues. It would be a muddled situation for all concerned.
John D Thomason
Hi, Grant18m,
I have always considered that "guaranteed payments" referred to services, and usually would not be applicable to limited partners. The definition from IRS Publication 541 - Partnerships, is:

Guaranteed Payments

"Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. This treatment is for purposes of determining gross income and deductible business expenses only. For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. Guaranteed payments are not subject to income tax withholding.

The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. They are also listed on Schedules K and K-1 of the partnership return. The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income."

So I see how the payments would be reported as "nonpassive income" on Schedule E. I haven't encountered this situation before, so I must admit I don't know the answer to the basis question. Do you own any "regular" units in addition to the preferreds? I wouldn't think owning the preferreds alone would make you a limited partner at all. I would think that the preferred holdings would be considered a capital contribution to the partnership,and would not be treated any differently than preferreds of a regular C-corp. But as I said, I really don't know. I'm adding this to my list of topics to investigate further. When I learn more, I'll get back to you.
Hi, alvins,
Good points. One benefit of the SA community is when others bring up situations that one wouldn't have considered and in fact wouldn't have thought would ever occur unless it was personally experienced. That is how SA can help broaden one's outlook - by making one aware of possibilities without having experienced them first.
Thanks for your insights.
John D Thomason
My honest answer is I don't know, but my best guess is I would not count on the K-1 or anything else from the partnership. As noted, the Capital Account as shown approximates basis, but it is really up to the partner to track basis and report everything correctly, which would include distributions in excess of basis.
John D Thomason
Additional Comment, To All Readers,
One potential point of confusion that I may have not been clear on is "when passive losses can be used". There are three hurdles: the first hurdle is the passive loss rules for PTPs. But even if this hurdle is "cleared", there are two more: the basis hurdle, and the at risk hurdle. A loss in excess of basis and / or the amount at risk in the PTP investment cannot be "used", even if, per the passive loss rules, it would be allowed.
The article should have stated this more clearly.
John D Thomason
To all readers,
Just now awoke (5/11/2015) to see that my article has been published. Thanks one and all for your comments and suggestions. I will take your suggestions under consideration, since I am now focusing on writing about investing and tax implications, as an area where I feel that I may have something worthwhile to contribute to the community of SA.
I see with some disappointment that the SA Editors, not being familiar with the topic, "corrected" some of the text, and thereby introduced errors. I will make an attempt to work with them to improve the accuracy of the content. The errors are not major, and I don't believe cause misinformation being disseminated, but in the interest of making a confused topic a little less confusing, I would like to fix them.
To have even a prayer of getting published, I had to delete the K-1 Part III line-by-line review section, which cut the article's length by 50%. I will be able to respond to questions about specific K-1 Part III boxes, if anyone cares to get my take on an item that is unclear to them as to how it should be handled.
John D Thomason
Agree completely with your analysis. KMI is my largest holding. Also a KMI pensioner, compliments of Coastal Corp & El Paso corp. For insight and a fascinating story, read "The Smartest Guys in the Room", the story of Enron. Rich Kinder was at one time slated to be CEO after Ken Lay, but Lay never left. So Mr. Kinder left instead, and when the opportunity came, he and his team picked up some great Enron assets at a good price, and KMP was on it's way to greatness. One telling line in the book was that when a former exec who had retired learned Rich Kinder left Enron, he immediately sold all his Enron stock, which was obviously a smart move, way before the fall. Just a little trivia for your readers.
Wow. Quite a few comments. If we could get a discussion going about MLPs in IRAs, we maybe could challenge Reel Ken for the comments record on SA!
I took a small position in SDRL when it dipped below 25, added a little more below that. Of course, I knew it was high risk, but, like many others, I didn't expect a total suspension of the dividend, only at most 50% or so. The oil price collapse is obviously more serious than initially predicted. While I fault management for saying the dividend was safe for at least the near term, if things are that bad, I can't fault the decision. But why say the div was "safe". Better to have at least added a caveat, such as "pending no further deterioration", or some weasel wording. That's my real complaint.