§751 Recapture: Up to 37% Ordinary Income on What You Thought Was Capital Gains

You've held an MLP for years, collected distributions, and watched the unit price appreciate. You sell, expecting to pay the long-term capital gains rate — 15% or 20% depending on your income. Then you get the Sales Schedule in your final K-1 package. A chunk of your gain isn't capital gain at all. It's ordinary income, taxed at your marginal rate — up to 37%.

This is Section 751 depreciation recapture, and it's the most expensive surprise in MLP taxation. It's not a bug, a penalty, or an audit flag — it's the standard IRS treatment for every partnership sale involving depreciated assets. The only surprise is that most investors don't know about it until they see the number.

Section 751 of the Internal Revenue Code deals with "hot assets" — unrealized receivables and substantially appreciated inventory. For MLP investors, the primary hot asset is accumulated depreciation on the partnership's physical infrastructure.

Here's the logic: MLPs own massive physical assets — pipelines, processing plants, storage facilities, compressor stations, fractionation plants. Every year, the partnership depreciates these assets and passes the deductions through to you via your K-1. Those deductions reduced your taxable income while you held the units. When you sell, the IRS "recaptures" that depreciation as ordinary income.

Think of it as the IRS saying: "You received tax-favored treatment on those depreciation deductions. Now that you're cashing out, we want the tax benefit back."

For midstream MLPs, §751 recapture typically includes three categories of depreciation:

• §1245 recapture: Equipment, compressors, gathering systems, and other personal property. Depreciation on these assets is recaptured in full as ordinary income.
• §1250 recapture: Buildings, certain structures, and real property improvements. Excess depreciation over straight-line is recaptured as ordinary income, with some taxed at the 25% "unrecaptured §1250 gain" rate.
• §1254 recapture: Oil, gas, and geothermal wells and related property. Intangible drilling costs (IDCs) and depletion previously deducted are recaptured as ordinary income. This is particularly significant for energy MLPs with upstream or gathering operations.

Your total gain on sale is split into two pieces:

Here's how §751 changes the tax math on a real MLP sale.

Note that the basis used here is the K-1-adjusted basis ($7,200), not the broker's basis ($12,600 — original purchase price of 300 × $42). If the investor had used the broker's number, the reported gain would have been only $900, massively understating both the capital gain and the §751 component. The two problems compound: wrong basis and §751 recapture.

You do not calculate the §751 split yourself. The partnership determines it based on the fair market value of its underlying assets at the time of your sale.

• The Sales Schedule (sometimes labeled "Section 751 Statement" or "Hot Asset Statement") is included with your final K-1 package — the K-1 for the year you sold.
• The §751 ordinary income amount may also appear in Box 20, Code AB on the K-1. For the complete Box 20 code reference, see Schedule K-1 Box 20 Codes.
• The Sales Schedule arrives with your K-1, which can be weeks or months after year-end. You won't know the exact §751 split until then.
• Most tax software (TurboTax, H&R Block) handles the split if you enter the Sales Schedule data correctly — but most investors don't enter it correctly because they don't understand what it means.

Enter your position details to see how the gain splits across three estimation scenarios. The actual §751 amount will be determined by the partnership's Sales Schedule.

You can't know the exact §751 number until the partnership calculates it. But you can get a reasonable estimate:

• Review cumulative depreciation: Look at your K-1 Box 1 over the years. Negative Box 1 values often reflect depreciation exceeding income. Sum the depreciation-related deductions across all years of ownership for a rough floor on §751 exposure.
• Rule of thumb: The longer you've held and the more capital-intensive the MLP, the larger the §751. For a typical midstream MLP held 5+ years, §751 commonly represents 30–60% of total gain.
• Check prior year Sales Schedules: If the partnership publishes an estimated §751 allocation (some do for planning purposes), use that as a guide.

Here's the good news that partially balances the §751 surprise. A suspended loss, when allowed, keeps the character of the K-1 deductions it came from, and §469 does not change the character of the sale gain (Reg. §1.469-1T(f)(2)(ii)(A); §1.469-1T(d)(1)). Gain on selling PTP units, including the §751 ordinary portion, is generally passive income of that PTP (apart from any part allocable to the partnership’s portfolio assets). It is combined with the PTP’s other income and current-year losses, and the PTP’s losses, current and prior-year, are allowed up to the PTP’s passive income and gains for the year (Form 8582 instructions, Special Instructions for PTPs). When you dispose of your entire interest in a fully taxable transaction to an unrelated party, the PTP’s overall loss for the year is no longer limited by the passive loss rules at all (IRC §469(g)(1)(A); §469(k)(3)).

During your years of ownership, if your K-1 showed net losses that exceeded your other income from that same PTP, the excess was suspended under the §469(k) rules and carried forward to later years (IRC §469(b); §469(k)(1)). You couldn't deduct it against wages, investment income, or even income from other PTPs.

At sale, the losses become allowable, up to the PTP’s passive income for the year on a partial sale, and without the passive limit on a fully taxable sale of your entire interest to an unrelated person. The allowed loss is reported on the form or schedule normally used, marked “From PTP” where the instructions say so: for an ordinary Box 1 loss, Schedule E, Part II (Form 8582 instructions, Special Instructions for PTPs). The gain is reported on its own forms. No rule assigns the loss to one kind of gain: the instructions report the loss on its own schedule and the gain on its own form, and §469 does not change the treatment of the gain (Reg. §1.469-1T(d)(1)). For investors who've accumulated years of suspended PTP losses, the allowed loss can substantially reduce the year's taxable income.

Track your suspended losses. The K-1 Basis Tracker records suspended losses each year so you know exactly how much offset you've accumulated before making a sell decision.

Under IRC §1014, when MLP units pass to heirs at death, the heirs receive a stepped-up basis to fair market value on the date of death. This has three consequences that interact powerfully:

1. All basis erosion is eliminated. The heir's basis resets to market value — wiping out years of distribution-driven basis decline.
2. All §751 recapture exposure disappears. The depreciation recapture that would have been ordinary income if the decedent sold is gone. The heir has no hot asset exposure.
3. Suspended passive losses expire unused. This is the downside — accumulated suspended losses cannot be used by the heir. They die with the original holder.

The IRS requires a disclosure statement attached to your return when you report §751 income from a partnership sale. This is a brief statement — not a separate form — that confirms you've reported the ordinary income per the partnership's Sales Schedule.