How MLP Distributions Erode Your Tax Basis Year After Year
IRC §733 requires that partnership distributions reduce your outside basis — dollar for dollar. Your broker ignores this. The IRS does not.
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IRC §733: Why Distributions Reduce Your Basis
Under IRC §733, a partner's adjusted basis is decreased (but not below zero) by the amount of money distributed to them by the partnership. This is the core mechanic of partnership taxation — not a tax benefit or loophole. When cash moves from the partnership to you, the tax code treats it as a return of your own capital, reducing your outside basis accordingly. Corporate dividends (1099-DIV) do not reduce basis. Partnership distributions (K-1 Box 19A) do.
After 10 years at 5% annual erosion, a $10,000 position has an IRS basis of $5,000 while the broker still shows $10,000. Every quarterly distribution widens this gap.
Why brokers don't track this: Brokers receive your 1099-B trade data and your original purchase price. They do not receive your K-1. They have no mechanism to incorporate K-1 adjustments — income allocations, liability changes, §743(b) adjustments, or the distribution reductions required by §733. The broker's cost basis is frozen at your purchase price. The IRS cost basis moves every year. This divergence is not a broker error — it is a structural limitation of the 1099 reporting system.
Two Things Happen to Your Basis Every Year
Each tax year, your outside basis changes due to two separate events reported on the K-1:
1. K-1 Income/Loss Allocation (Basis Worksheet Lines 2-6)
Your share of partnership net income or loss flows through on the K-1. Ordinary income (Box 1) and other income items increase basis; losses and deductions decrease it. Most midstream MLPs report net losses or modest income in Box 1 because accelerated depreciation on pipeline infrastructure exceeds operating income.
2. Cash Distributions Under §733 (Basis Worksheet Line 8)
The actual cash you receive each quarter — reported on K-1 Box 19A — reduces your basis dollar for dollar. For midstream MLPs, quarterly distributions typically total $1.50 to $3.50 per unit annually, and 70–90% of this amount exceeds the income allocated to you.
The income allocation happens first on the IRS Partner's Basis Worksheet. Then distributions reduce the result. Because distributions almost always exceed net income for midstream MLPs, your basis declines every year — this decline is the erosion.
Erosion Rates by MLP Category
Erosion speed depends on the ratio of cash distributions to taxable income, which varies by business model.
| Category | Examples | Annual Erosion | Typical ROC % | Why |
|---|---|---|---|---|
| Pipeline / Midstream | EPD, MPLX, WES, PAA | ~3–6% | 70–85% | Large depreciation on pipeline assets shelters most income. Distributions modestly exceed allocations. |
| Multi-Entity Midstream | ET (3 K-1s) | ~4–7% | 75–90% | Three sub-entities each erode separately. Combined rate higher than single-entity peers. |
| Fuel Distribution | SUN, CAPL | ~5–9% | 60–75% | Higher Box 1 income but also higher distributions. ROC percentage is lower, but absolute erosion is faster because distribution yields are higher. |
| LNG / Terminal | CQP | ~8–15% | 80–95% | Very high distributions relative to unit price. Accelerated depreciation on LNG terminal assets. Erosion runs 2–3x the pipeline rate. |
| Royalty / Mineral | NRP, BSM | ~10–20%+ | 85–95%+ | Depletion-based deductions (not depreciation). Mineral rights deplete faster than pipelines. Basis can approach zero within 3–7 years. |
These are illustrative ranges based on recent K-1 data. Your actual erosion rate depends on your purchase price, the year's K-1 allocations, and distribution changes. Use the projection tool below with your specific data.
Worked Example: $10,000 Position Over 10 Years
$10,000 starting basis at three erosion rates. Broker basis remains $10,000 throughout — brokers do not adjust for K-1 activity.
| Year | 3% Erosion | 5% Erosion | 8% Erosion | Broker Basis |
|---|---|---|---|---|
| 0 (Purchase) | $10,000 | $10,000 | $10,000 | $10,000 |
| 1 | $9,700 | $9,500 | $9,200 | $10,000 |
| 2 | $9,400 | $9,000 | $8,400 | $10,000 |
| 3 | $9,100 | $8,500 | $7,600 | $10,000 |
| 5 | $8,500 | $7,500 | $6,000 | $10,000 |
| 7 | $7,900 | $6,500 | $4,400 | $10,000 |
| 10 | $7,000 | $5,000 | $2,000 | $10,000 |
At Year 10, the broker still reports your position at $10,000 of cost basis. But the IRS sees $7,000 (pipeline), $5,000 (midstream), or just $2,000 (LNG/fuel). If you sell at $12,000 market value, your broker's 1099-B shows a $2,000 gain. The IRS expects you to report a $5,000 to $10,000 gain — and part of that gain is ordinary income under §751, not capital gains.
This gap is not theoretical. It is the single most common source of IRS CP2000 notices for MLP investors — the IRS's automated system flags the mismatch between your 1099-B and your correct basis.
How Much Has Your Basis Eroded?
Enter your K-1 data and see exactly how far your basis has dropped from your original purchase price. Free, no signup required.
In the K-1 tracker, typing your numbers in uploads nothing; an uploaded K-1 PDF is read by a third-party AI provider. Privacy
Open K-1 Basis TrackerWhat "Return of Capital" Really Means
The portion of distributions that exceeds your allocated income is called return of capital (ROC). It is not a special category or tax benefit — it is simply the §733 basis reduction in action. Here's a typical single-year breakdown for a midstream MLP:
The $1.65 per-unit erosion is the return of capital. It is not taxed now, but it reduces your basis — increasing your eventual gain at sale, part of which will be §751 ordinary income.
Project Your Basis Erosion
Enter your position details to see how your basis may erode over time and when it could reach zero.
Basis Erosion Projection
See when your basis could reach zero at the current distribution rate
% of distribution offset by allocated income
Basis reaches zero in ~15 years
After that, distributions become immediately taxable as capital gains under IRC section 731.
When Erosion Reaches the Floor
Your outside basis cannot go below zero. Under IRC §731(a), once distributions (plus losses) would push basis below zero, basis stops at zero and any excess is immediately recognized as capital gain — even though you haven't sold a single unit. This is the "phantom income" that catches long-term MLP holders off guard.
For a pipeline MLP eroding at 3% annually, this threshold arrives around Year 20–25. For a royalty MLP like NRP eroding at 15%+, it can arrive in Year 3–5. The erosion rate table above tells you roughly how long you have before reaching this trigger point.
For a detailed walkthrough of your options at zero basis — hold for stepped-up basis at death, sell and crystallize the gain, or purchase additional units to create fresh basis — see What Happens When Your MLP Basis Reaches Zero.
The §751 Recapture Connection
Basis erosion doesn't just increase the size of your gain — it changes the character of your gain. The depreciation that sheltered partnership income and accelerated your basis erosion creates a §751 "hot asset" recapture obligation. When you sell, the IRS requires that the portion of gain attributable to accumulated depreciation be taxed as ordinary income (up to 25% for §1250 property), not at the lower capital gains rate.
The faster your basis erodes, the larger your §751 recapture exposure grows. A midstream MLP held for 10 years at 5% annual erosion has accumulated $5,000 of basis reduction on a $10,000 position — and a significant portion of that erosion traces back to depreciation, which creates §751 recapture at sale.
For the full mechanics of recapture computation and how to read §751 on your K-1, see Section 751 Depreciation Recapture Explained.
Track Your Exact IRS Basis
The K-1 Basis Tracker computes every line of the IRS Partner's Basis Worksheet — including erosion, §751 exposure, and the broker-vs-IRS gap.
In the K-1 tracker, typing your numbers in uploads nothing; an uploaded K-1 PDF is read by a third-party AI provider. Privacy
Open K-1 Basis TrackerKey Takeaways
- 1.IRC §733 requires that partnership distributions reduce your outside basis — this is structural, not optional
- 2.Erosion rates vary dramatically by MLP type: 3–6% for pipelines, 8–15% for LNG, 10–20%+ for royalty MLPs
- 3.Your broker never adjusts for erosion — after 10 years, the IRS basis can be 30–80% below what your broker reports
- 4.At zero basis, excess distributions become immediately taxable capital gain under §731(a)
- 5.Erosion increases both the size of your gain at sale and its §751 ordinary income component
Frequently Asked Questions
Under IRC §733, cash distributions from a partnership reduce the partner's outside basis dollar for dollar. MLP distributions are partnership distributions — not dividends. They are not taxable when received, but they shrink your basis, increasing the taxable gain when you eventually sell.
It depends on the MLP category. Pipeline MLPs (EPD, ET, MPLX, WES, PAA) erode basis at roughly 3–6% of original cost per year. Fuel distribution MLPs (SUN, CAPL) erode faster due to higher Box 1 income offsets. LNG MLPs like CQP can erode at 2–3x the pipeline rate. Royalty MLPs (NRP, BSM) erode fastest — depletion-based deductions push ROC above 85%.
No. Brokers report your original purchase price and never adjust for K-1 activity. After five years of holding a midstream MLP, the gap between your broker's reported basis and your IRS-adjusted basis can exceed 25% of your original purchase price. This creates a large discrepancy on your 1099-B at sale.
Basis erosion is the annual reduction of your outside basis caused by distributions exceeding income allocations — it happens every year you hold the MLP. Basis reaching zero is the threshold where erosion has fully consumed your original cost. Once at zero, further distributions become immediately taxable as capital gain under IRC §731(a), even though you haven't sold.
Not without reducing your distributions. Basis erosion is a structural feature of MLP taxation — it's the mechanism that makes distributions tax-deferred. The only ways to add basis back are: purchasing additional units (new lots get fresh basis), or receiving K-1 income allocations that exceed distributions in a given year (rare for most midstream MLPs).
Related Articles
What Happens When Basis Reaches Zero
The §731 trigger point — phantom income, taxable distributions, and your options
Why Your Broker's Basis Is Wrong
Your 1099-B shows one number, the IRS expects another
Section 751 Recapture
Why part of your MLP gain is taxed as ordinary income at sale
K-1 Basis Worksheet Explained
IRS Partner's Basis Worksheet — line by line
Energy Transfer (ET) K-1 Guide
Three entities with separate basis erosion each
Enterprise Products (EPD) K-1 Guide
The most widely held MLP — typical 12-18 year erosion
MLP Tax Center
All guides and tools
Track Your Real Basis — Free
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Open K-1 Basis TrackerIMPORTANT: This tool provides estimates for educational and informational purposes only. It does not constitute tax, legal, or financial advice. You are solely responsible for the accuracy of information you enter and for all tax filing decisions. Always consult a qualified tax professional (CPA, EA, or tax attorney) before making tax decisions based on this tool's output.
Lucas Andersen is not a CPA, Enrolled Agent, or tax attorney. This tool is not a substitute for professional tax preparation.