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What are PTPs?

Are they the same thing as MLPs?

What kinds of companies operate as PTPs?

What are the advantages of investing in PTPs?

How are PTP units different from corporate stock?

If distributions are tax-deferred, is a PTP investment is tax-free until I sell it?

What if the income and deductions from the PTP come out to a net loss?

When do distributions become taxable?

Can I use the income I'm allocated by a PTP to soak up some of my passive losses from other investments?

What do I do about my PTP investment at tax time?

Can I hold PTP units in my IRA?

If my IRA's PTP investment does generate UBTI exceeding $1,000 do I have to pay the tax?

What are PTPs?

Publicly traded partnerships (PTPs) are what their name implies: limited partnerships the interests in which, known as "units," are traded on public securities exchanges much like corporate stock. Buying PTP units makes you a limited partner in that PTP.

Are they the same thing as MLPs?

Yes, PTPs are also known as "master limited partnerships," or MLPs. The term "publicly traded partnership" more accurately describes the important difference between PTPs and other limited partnerships, i.e., the public trading of their units, which makes them a liquid investment.

What kinds of companies operate as PTPs?

Due to the requirements of the tax code, PTPs are predominantly in the energy, timber, real estate, or mortgage security business. There are a few PTPs in other businesses, however.

What are the advantages of investing in PTPs?

There are two main advantages:

Because the PTP itself does not pay tax, it is able to pass on more of its earnings to you than a corporation can. If you are looking for an investment that will provide you with regular, substantial, cash distributions, you should consider PTPs.
Investing in a PTP gives you a substantial tax advantage. The cash distributions you receive from a PTP are tax-deferred, usually until you sell your units, when they are included in your taxable gain. And your share of the PTP’s taxable income, on which you do pay tax, is reduced, often to a low level, by the PTP’s losses and deductions. Corporate shareholders, on the other hand, are not able to use a corporation’s tax losses to offset the income they receive from the corporation.

How are PTP units different from corporate stock?

In some ways, they are very similar. They may be bought and sold on the New York, American, and NASDAQ exchanges, and most of them pay a regular dividend, known as a "distribution." The big difference is that because PTPs are not corporations, they do not pay a corporate tax. This leaves more of their earnings free to pass on to you. Moreover, for most of the time you hold your PTP units, you will not have to pay tax on the distributions the way you do on corporate dividends. They are considered a tax-deferred "return of capital"-- that is, payback on your investment. On the other hand, you will be responsible for paying tax on your share of the partnership’s taxable income. However, PTPs generally pay cash distributions that are well in excess of any tax owed.

If distributions are tax-deferred, is a PTP investment tax-free until I sell it?

Not quite. As a limited partner, you will be allocated a share of the PTP's income and will be responsible for paying tax on it. However, you will also be allocated a share of the PTP's deductions (such as depreciation), losses and credits. These will offset much, and in some cases all, of the income. The unitholder's cash distributions usually exceed the income tax owed by a comfortable margin.

What if the income and deductions from the PTP come out to a net loss?

A net loss from a PTP is considered a "passive loss" under the tax code. If you come out with a net loss for the tax year, you cannot deduct it from your taxable income. However, you can carry it forward into future tax years and use it to reduce your taxable income from the same PTP. If any of the loss is left over when you sell your PTP, you can deduct it from your other income in that year.

When do distributions become taxable?

You could pay tax on your distributions:

If your adjusted basis in the units reaches zero. Your original basis is the price you paid for the units. It is adjusted downwards with each distribution and each allocation of deductions, and upwards with each allocation of income (don't worry about keeping track of all this--the PTP will do it for you).
If you sell your units at a gain. Because the distributions have decreased your basis, they have increased the amount of taxable gain (which equals your sales price minus basis) on the sale. Some of your gain will be taxed at the lower capital gains rate, but the portion of the gain that results from deductions such as depreciation lowering your basis downwards will be taxed as ordinary income.

Can I use the income I'm allocated by a PTP to soak up some of my passive losses from other

investments?

No. Passive income may only be offset by passive losses from the same PTP, and passive losses from the PTP may not be offset against passive income from another investment. However, if the result of netting a PTP's passive income and loss is net income, it is then considered portfolio income, and other investment expenses may be deducted from it.

What do I do about my PTP investment at tax time?

Because you own a share of all the PTP's income and loss items, accounting for your PTP investment on your tax form is more complex than accounting for corporate stock, but it's not as bad as many people fear. When the income tax filing season arrives, you will receive a schedule K-1 from the partnership. The K-1 will tell you your share of all the PTP's tax items. But the people who send you the K-1 won't just give you a bunch of numbers and expect you to know what to do with them. They will give you a complete package that will show you where everything goes on your tax return. In addition, for most PTPs an investor relations staff is just a phone call away if there is anything in the K-1 package that you don't understand.

Additional information can be found in the following two IRS publications by clicking on the links below:

Publication 541: Partnerships, 2003 (rev. Nov. 2004)

Partner's Instructions for Schedule K-1 (Form 1065) for 2004

Can I hold PTP units in my IRA?

Yes, subject to some limitations. Partnership income allocated to a tax-exempt organization or a retirement trust like an IRA (including Roth IRAs) may be considered unrelated business taxable income (UBTI) subject to tax. However, it will not be taxed as long as the amount of this income (and all other sources of UBTI), minus the IRA's share of partnership deductions, does not exceed $1,000 in any year. Even if there is some tax on the IRA's allocated share of PTP income, the PTP distributions will generally be high enough to provide a favorable return on an after-tax basis.

If my IRA's PTP investment does generate UBTI exceeding $1,000 do I have to pay the tax? How is it paid?

You do not pay any tax yourself: the IRA is the unitholder and therefore is the taxpayer. The custodian of the IRA will be responsible for filing an IRS Form 990T. The IRA's share of all PTP income and of the deductions connected with the production of that income (as well as the income and deduction from any other partnership investments) is netted and entered on line 5, "Income (loss) from partnerships and S corporations." The "specific deduction" of $1,000 is entered on line 33. The deduction is subtracted from the amount on line 5, and tax is paid (out of the IRA funds) on the result, at the corporate tax rate. A statement showing the IRA's share of the partnership's gross income, and of the partnership deductions directly connected with producing the income, should be attached to the return.

Do you have a question that is not answered here? Call Mary Lyman at 202-973-4515, or e-mail your question to [email protected]. Please be aware that while we can provide general information on PTPs and how they are taxed, we are neither tax advisors nor investment advisors and cannot provide specific tax advice or investment recommendations.