MLPs in a Living Trust: What Your Attorney Didn't Tell You

My MLPs are held in a revocable living trust. Yours probably are too, if you've done any estate planning at all. While I'm alive, this changes nothing about my taxes — the trust is invisible to the IRS under §§671–679. My K-1s report to my SSN, my basis tracking is unchanged, my §199A deductions work normally. The trust might as well not exist for income-tax purposes.

The problem isn't today. The problem is the day after I die.

On that day, my revocable trust becomes irrevocable. My successor trustee inherits my MLP positions inside a structure that suddenly faces trust-rate compression, potential UBTI, and K-1 administrative costs that didn't exist 24 hours earlier. If my trustee doesn't understand the three options available — and most don't — my heirs get the worst of them by default.

I've run the numbers for a canonical 5-MLP portfolio (EPD, ET, MPLX, WES, PAA at standard sizes) across all three options over the first 5 years after the grantor's death. The gap between the best and worst outcome is $14,288. The trustee's decision in the first 30 days determines which outcome the heirs get. For the broader argument about why direct hold generally beats trust structures, see When Step-Up Basis Beats a Trust. This article is about what happens inside the trust you already have.

A revocable living trust is a grantor trust under IRC §§671–679. All income, deductions, gains, and losses flow through to the grantor's personal return as if the trust didn't exist. Specifically for MLP holders:

• Your K-1s report to your Social Security number, not the trust's EIN (in most arrangements the trust doesn't even have its own EIN during the grantor's life).
• Your basis tracking is unchanged — same IRS Partner's Basis Worksheet, Lines 1–14.
• §199A QBI deduction applies normally at your individual thresholds and rates.
• No UBTI concern — that's an IRA and non-grantor-trust problem.
• No Form 1041 is filed for a grantor trust.
• Your cost basis continues to erode from distributions exactly as it would in your own name.
• §1014 step-up is preserved: revocable trust assets are in the gross estate.

If your attorney retitled your brokerage account into your revocable trust and told you “you're all set” — they were right, for now. The tax mechanics are identical to direct ownership. The only thing that changed is the ownership record at your broker.

The moment the grantor dies, the trust becomes irrevocable by operation of law. The trust is now a separate taxpayer and needs its own EIN. Basis on all MLP units steps up to FMV under §1014(a). Accumulated §751 recapture from the grantor's lifetime is eliminated. Good news so far.

Then the trustee has a decision to make, and it's a consequential one. Three options:

Most successor trustees don't know these options exist. Most estate attorneys didn't explain them. The trustee defaults to Option B — hold everything — because doing nothing feels safest. For MLP positions specifically, doing nothing is the most expensive choice.

Same 5-MLP portfolio used throughout this site: EPD 1,000 units, ET 500, MPLX 500, WES 300, PAA 500. All positions enter Year 1 at stepped-up basis (total FMV $195,695, total basis $195,695 — zero embedded tax as of Day 1). Canonical engine assumptions, 5-year horizon.

Option A beats Option B by $14,288 over 5 years. Most of that gap is not the federal tax-rate difference — it's the trust's administrative cost (CPA + multi-state filings) compounding. The rate-compression effect grows larger over longer horizons, as basis erodes again toward zero and the taxable portion of each year's K-1 increases.

Option C looks huge on day one — $195,695 in cash vs. Option A's $34,681 — but that's comparing a lump sum against five years of distributions alone. Option A also retains roughly $232,425 in appreciated MLP units at Year 5. Expressed differently: it takes about 28 years of Option A distributions (at today's rates) to equal the Option C lump sum, ignoring the retained units entirely. For heirs with a long horizon who want ongoing income, Option A is typically the answer. For heirs who want simplicity or don't need the K-1 complexity, Option C is a legitimate choice.

Print this section. Put it in the trust binder next to the trust document. If the successor trustee ever needs it, they will be looking for it at exactly the worst possible moment in their life, and they will not want to guess.

The trustee-letter above is the trustee's perspective. This is the beneficiary's. If you've just learned a trust holds MLP positions and you are the beneficiary, these are the questions that matter:

For the complete 90-day guide for heirs — phone scripts for the broker, documentation templates, day-by-day action items — see The MLP Inheritance Playbook.

When the grantor dies in June, the MLP issues one K-1 for the full calendar year. But that K-1 covers two taxpayers:

• January 1 through date of death → decedent's final Form 1040
• Date of death through December 31 → trust's Form 1041

The MLP does not split the K-1. The CPA has to allocate — across every box: ordinary income, distributions, liability allocations, §199A data, state-source information, §751 deprecation estimates. Allocation methods (daily proration under §706, interim closing of the books, specific identification) produce materially different results, and the method must be applied consistently across every line of every K-1.

If the CPA you use has never handled a death-year MLP K-1 allocation, get a referral. This is not general-practice territory. Bad allocation in the death year creates compounding errors in every subsequent year.

If the trustee is forced to hold MLPs in the trust after death (Option B), trust-rate compression can cost thousands. §663(b) is the pressure-relief valve.

Under §663(b), a trustee can make distributions within 65 days after the end of the tax year and elect to treat them as if they were made on the last day of the prior year. For a calendar-year trust, that window runs from January 1 through about March 6 of the following year. The mechanics:

• MLP K-1 income accumulates inside the trust during the year.
• By March 6 of the following year, the trustee distributes cash or trust income to beneficiaries and specifically elects §663(b) on the Form 1041 for the prior year.
• The trust takes a Distributable Net Income (DNI) deduction for the distributed amount, zeroing out (or reducing) the trust's taxable income.
• The beneficiaries receive Schedule K-1 (Form 1041) showing their share of DNI and pay tax at their individual rates.

The election is made on Form 1041 by checking the §663(b) box and filing timely. It is not automatic — the trustee must affirmatively elect it, every year, for every distribution the trustee wants to pull back.

When this matters most: a trust holding MLPs under restrictive distribution terms, where the trustee can't simply hand the units over to beneficiaries but can distribute income. §663(b) turns trust-rate compression from a permanent tax into a cash-flow timing question. If your CPA hasn't mentioned §663(b) to you and your trust holds MLPs, ask about it at the next meeting.

Many trusts have staggered-distribution provisions: “Distribute one-third at 25, one-third at 30, remainder at 35,” or “Hold in trust until the beneficiary demonstrates financial responsibility.” If the trust terms require holding the MLP units, the trustee can't simply distribute them on Day 1. But “hold” does not mean “pay trust-rate tax on everything.” Mitigations, in rough order of usefulness:

1. Distribute income, not principal. Most trusts restrict distribution of principal (the MLP units themselves) but allow or require distribution of income. The taxable portion of MLP distributions (the non-ROC portion flowing through the K-1) can be paid out to beneficiaries annually and deducted as DNI — pulling that income out of trust rates.
2. Use the §663(b) 65-day election (Section 6) to retroactively distribute income the trustee didn't push out during the year.
3. Check trustee discretion. Many trusts give the trustee HEMS discretion (health, education, maintenance, support). In-kind distribution of MLP units may fall within HEMS if the beneficiary has a present need. Consult the trust document and an attorney — this is fact-specific.
4. In-kind distribution of specific assets. Some trust terms restrict cash distributions but allow distribution of specific property. MLP units transferred in-kind move the K-1 reporting burden (and the tax rate) from the trust to the beneficiary permanently.
5. §645 election: bridge the first 2 years. A qualified revocable trust can elect under §645 to be treated as part of the decedent's estate for up to 2 years post-death. This lets MLP income flow through the estate's Form 1041, which can adopt a fiscal year and defer recognition. Short-term bridge, not a permanent solution, but it buys the trustee time to develop the distribution plan.

The worst outcome is a trustee who does nothing because the trust document seems restrictive. Almost every trust has a mechanism for managing income — the trustee just needs a CPA who knows how to use them.

In community property states, both halves of community property step up at the first spouse's death under §1014(b)(6). The surviving spouse now holds MLP units with a completely fresh basis — economically, as if they purchased the units at today's market price. That starts a new planning cycle:

• Basis resets to full FMV at the first death.
• Distributions resume. ROC portion erodes basis again from the new, higher starting point.
• Over the surviving spouse's remaining lifetime — commonly 15–25 years — basis drifts back toward zero.
• At the surviving spouse's death, §1014 applies again, eliminating the next layer of deferred tax for the next generation.

For a 60-year-old surviving spouse inheriting 1,000 EPD units stepped up to $62,826 (Year 15 FMV assumption), the new basis has years of headroom before erosion reaches the zero-basis zone. Distributions during that window are pure tax deferral. No trust complexity is required — just direct ownership, patience, and §1014.

This is generational tax planning at its most elegant. First spouse's death: step-up clears all deferred tax. Surviving spouse holds, collects distributions, lets basis erode. Second death: step-up clears everything again. The children inherit with clean basis. The cycle can run for three generations before anyone pays meaningful capital-gains tax. It works cleanly inside a revocable trust and it works cleanly with direct ownership.

The extension of Article 1's “buy more, never sell” thesis: this is the same strategy, viewed across generations.

Community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin. I'm in Washington — this one matters to me personally.

In a common-law state, only the decedent's half of jointly held MLP units receives §1014 step-up at the first spouse's death. In a community property state under §1014(b)(6), both halves step up, including the surviving spouse's.

For a married MLP investor in Washington state with significant basis erosion, the community-property double step-up can eliminate roughly twice the deferred tax compared to an identical investor in New York. This is a substantial enough advantage that couples relocating late in life sometimes optimize around it — though residency and property-title rules are specific and an estate attorney should be consulted before restructuring. For the full state-by-state dollar value of the §1014(b)(6) double step-up, including the California state-tax elimination math and a printable 7-item action checklist, see Community Property and MLPs: The Double Step-Up Nobody Mentions.

Don't abandon your trust. The revocable living trust serves legitimate, valuable purposes that have nothing to do with MLP taxation:

• Probate avoidance. MLP units in a trust transfer without court supervision. In states with expensive or slow probate (California, New York, Florida), this alone can justify the trust — probate can cost 2–5% of the estate and take months.
• Incapacity planning. If you become incapacitated, your successor trustee can manage MLP positions (collect distributions, process K-1s, handle state filings) without court-appointed conservatorship.
• Privacy. Probate is public record. Trust administration is private.
• Multi-state property consolidation. If you own real estate in multiple states, the trust avoids ancillary probate. Your MLPs don't create this problem, but the trust may hold other assets that do.

The revocable living trust is the right structure for most MLP holders. §1014 step-up is preserved. Probate avoidance is real. Incapacity protection is important. The only thing you need to add is a specific written instruction to your successor trustee about what to do with the MLP positions on Day 1 — the “Letter to Your Successor Trustee” above. That's what this article is for.

Coming soon: What happens when a US revocable trust holds MLPs and the beneficiaries are Norwegian residents — treaty implications, FATCA reporting, Norwegian wealth-tax treatment of trust interests, and dual filing requirements.