The main problems with master limited partnerships are tax and structural, not performance. A high headline yield can be genuinely attractive, but MLP ownership brings a Schedule K-1 instead of a 1099, potential tax filings in every state where the partnership operates, a running basis calculation that falls on you rather than your broker, a deferred tax bill that lands when you sell, a UBTI trap in retirement accounts, and a governance structure that tilts toward the general partner. None of this is speculative; it is built into the MLP model, and it can quietly eat a meaningful piece of the yield that drew you in.
The K-1 Replaces Your 1099, and It Shows Up Late
Every MLP investor receives a Schedule K-1 (Form 1065) reporting their 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 has until March 15 to file its return, or September 15 with an extension.
You cannot complete Form 1040 accurately without K-1 data, so if one of your MLPs is late, your whole return waits. Many investors end up filing an extension for that reason alone. The K-1 itself 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 it wrong is easy. Catching the error later is expensive.
You May Owe Taxes in States You’ve Never Visited
A single MLP can operate pipelines, terminals, or processing plants across a dozen or more states. Because partnership income passes through at the state level as well as the federal level, you may owe nonresident income tax in every state where the MLP earns money.
Some states exempt nonresidents below a minimum income threshold, and thresholds vary widely — from a few hundred dollars in some states to several thousand in others, with a handful requiring a filing at any amount of income earned there. Nine states have no individual income tax at all. Even so, one MLP position can generate three, five, or ten additional state returns, each with its own forms and rules. Preparation fees can chew through the yield advantage that made the MLP look appealing in the first place.
Tracking Your Basis Is Your Job
Your cost basis in MLP units gets adjusted every year. Income allocations increase it. Losses, deductions, and distributions decrease it. 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.
Your brokerage firm does not track this. That job is yours. The annual K-1 provides the pieces, and many partnerships offer online portals with historical allocation data, but assembling an accurate running tally over the years you hold the units is on you. Sell after a decade without a reliable basis record and the 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 made since you bought in.
The Tax Bill Waiting for You at Sale
All those years of tax-sheltered distributions and pass-through depreciation come due when you exit. Two mechanics drive this.
First, return-of-capital distributions reduce basis but cannot push it below zero.2eCFR. 26 CFR 1.705-1 – Determination of Basis of Partner’s Interest Once basis hits zero, any further cash distribution triggers 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 Because your basis is lower than what you paid, the reported gain on sale is larger than your actual economic profit.
Second, a portion of that gain does not qualify for long-term capital gains rates. Under Section 751, the gain attributable to depreciation the partnership passed through to you over the holding period is reclassified as ordinary income.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 sell. Only the remainder qualifies for the lower capital gains rate.
The partnership’s final K-1 for the year of sale gives you the ordinary-vs-capital split. Your 1099-B cannot make that distinction, so investors who rely on the broker’s form alone will almost certainly misreport the transaction.
Why MLPs and Retirement Accounts Don’t Mix
Holding MLP units inside an IRA, 401(k), or other tax-exempt account introduces 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 entity, 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 structure makes it worse. IRAs are taxed on UBTI at trust 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 hits at just $15,650 of taxable income.7Internal Revenue Service. Instructions for Form 990-T Modest UBTI amounts reach the top marginal rate far faster than they would on a personal return. Add the cost of filing a separate return for the IRA, and the math rarely works. Most advisors steer clients away from holding individual MLP units in retirement accounts entirely.
Sector Concentration and Growth Constraints
To keep partnership tax treatment, an MLP must earn at least 90% of its gross income from qualifying sources each year. The statute defines qualifying income primarily as revenue from natural resource activities: exploration, production, transportation, processing, refining, and storage of minerals, oil, gas, and related products.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 count, but the overwhelming majority of MLPs cluster in midstream energy: pipelines, terminals, and processing plants.
This means MLPs cannot meaningfully diversify into unrelated businesses without jeopardizing their tax status. When energy prices collapsed in 2014–2016, the entire MLP asset class fell together. An investor who thought they owned a diversified basket of MLPs actually owned 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, which dilutes existing investors, or taking on debt. The model works well in a low-rate, rising-energy environment. It struggles in most other scenarios.
Governance Tilts Toward the General Partner
The general partner in an MLP typically controls operational and strategic decisions while holding a small equity stake. Partnership agreements also define fiduciary duties far more narrowly than corporate law does. A GP can often take actions that benefit itself at limited partners’ expense as long as those actions don’t violate the specific terms of the agreement. Corporate directors owe shareholders a duty to act in their best interest. The MLP bar is considerably lower.
Incentive Distribution Rights
Incentive Distribution Rights are the sharpest expression of that misalignment. IDRs give the general partner an escalating share of distributable cash flow once quarterly distributions to limited partners cross defined thresholds. The structure is tiered, and at the highest tiers the GP can capture up to 50% of every incremental dollar distributed.
The GP has a strong incentive to push distributions higher, which encourages aggressive acquisitions funded by new equity and debt. Limited partners bear the risk of overleveraging and overpaying, while the GP collects its escalating cut. IDRs also raise the partnership’s cost of equity over time, making it progressively harder for growth to benefit the limited partners who fund it.
Related-Party Deals and Limited Voting Rights
The GP frequently transacts with affiliated entities it also controls, purchasing services or assets at prices the GP sets. These deals appear in public filings, but limited partners have almost no practical ability to challenge pricing or block a transaction. LP voting rights are typically restricted to extraordinary matters such as removing the GP for cause, and even that threshold is usually designed to be nearly unreachable.
Where MLPs Actually Work Well
Two features do favor MLP holders, and both matter for the trade-off calculation.
MLP investors can claim a 20% deduction on qualified publicly traded partnership income under Section 199A.9Internal Revenue Service. Qualified Business Income Deduction The deduction, originally set to expire after 2025, was made permanent by the One Big Beautiful Bill Act signed in July 2025. For an investor in the 37% bracket, a 20% deduction on MLP income effectively drops the rate on that income to about 29.6%. Unlike the QBI deduction for other pass-through entities, this one is not limited by W-2 wages or capital invested.
The estate side is even more striking. At death, heirs receive a stepped-up basis equal to the fair market value of the units on the date of death. That step-up wipes out the accumulated deferred tax liability, including the return-of-capital reductions and the depreciation recapture that would have generated a large ordinary income bill on sale. With a Section 754 election in place, the heir’s share of the partnership’s internal asset basis is also adjusted upward, so future depreciation and gain calculations start from fair market value at inheritance. For long-term holders with estate planning intentions, the deferred tax “bomb” becomes a feature. Some investors buy MLPs specifically to hold them until death rather than sell during their lifetime.
Simpler Alternatives and What They Cost You
Investors who want energy infrastructure exposure without the K-1 mechanics have two main fund structures to consider.
Funds organized as C-corporations can hold 90–100% MLPs and issue a standard Form 1099-DIV. No K-1, no multi-state returns, no UBTI concern in retirement accounts. The price is corporate-level tax on the fund’s income and unrealized gains. The fund accrues a deferred tax liability at roughly the 21% federal corporate rate plus a few points for state tax, which drags on returns. In a rising market, a C-corp MLP ETF meaningfully underperforms the underlying MLP index. In a falling market, the shrinking deferred tax liability provides a modest cushion.
Regulated investment companies (most mutual funds and ETFs) can hold MLPs but are capped at 25% of fund assets in MLP securities. They pass through income without corporate-level tax but deliver diluted MLP exposure mixed with other energy equities. Investors in C-corp MLP funds also lose the Section 199A deduction, because the income arrives as a corporate dividend rather than qualified PTP income.
For investors who value simplicity, the fund route is usually worth the trade-off. For those willing to manage the complexity, direct MLP ownership can still deliver better after-tax results, particularly for long-term holders whose exit strategy is inheritance rather than sale.