Understanding taxes on MLP K-1 distributions when reinvesting - what happens to my cost basis?

The way MLP (Master Limited Partnership) K-1 distributions work is a bit complex, but you're on the right track with your understanding. With MLPs, when you receive a distribution, a portion is typically classified as Return of Capital (ROC), which does lower your cost basis as you mentioned. However, reinvesting that distribution is essentially a new purchase of additional units. So in your example, if you receive a 30c distribution that's mostly ROC, your cost basis on your original units would go down by that amount. But then when you reinvest, you're purchasing new units at the current market price. These new units have their own cost basis (the price you paid for them), separate from your original investment. Think of it like two separate transactions: 1) receiving a distribution that lowers your cost basis on existing units, and 2) using that cash to buy new units at a new cost basis. You'll need to track these separately.

After struggling with MLP taxes for the last couple years, I found this amazing tool at https://taxr.ai that helped me decipher my K-1 forms. For ET specifically, they have this feature that breaks down exactly how the distributions affect cost basis when reinvesting. I was confused just like you about tracking all the different parts of distributions and what happens when reinvesting. The nice thing is they can analyze your specific K-1 form and show you how to track cost basis for each lot of units you own, including the reinvested distributions. Made my life so much easier than trying to piece it together from random internet advice.

Just wanted to follow up - I finally tried taxr.ai for my MLP nightmare and it was a game changer! It actually showed me that I'd been calculating my cost basis wrong for 2 years. For my ET investment specifically, it showed me exactly how to track both the original investment and the reinvested distributions separately. The tool broke down each distribution into its components (ROC, ordinary income, etc.) and showed exactly how each affects cost basis. Even better, it created a running schedule of my adjusted basis that I can update with each new distribution. Much better than my mess of a spreadsheet!

If you're having trouble getting answers about your MLP tax questions, calling the IRS directly can sometimes help, but getting through is nearly impossible. I discovered https://claimyr.com which got me connected to an actual IRS agent in about 15 minutes when I was completely lost on how to report my K-1. You can see how it works here: https://youtu.be/_kiP6q8DX5c I was stuck on this exact same question about reinvested distributions from MLPs and needed official guidance. The IRS agent explained that reinvested distributions don't cancel out the cost basis reduction - you're still responsible for tracking all the components separately. Saved me from a potentially expensive mistake.

I have to eat my words here. After complaining about both services mentioned above, I tried Claimyr out of desperation when I realized I'd been reporting my MLP income completely wrong. Got connected to an IRS tax specialist in about 20 minutes who walked me through exactly how to handle the reinvested distributions on my K-1. Turns out I should have been tracking each reinvestment as a separate lot with its own cost basis, while still reducing the cost basis of my original investment by the ROC portion. The agent even emailed me an IRS publication page that specifically addressed MLPs. Saved me from what could have been a messy audit situation.

Just want to add something important that nobody's mentioned yet. With MLPs, when your cost basis reaches zero due to ROC distributions, any additional ROC distributions become taxable as capital gains in that tax year. You don't wait until you sell. So keep really good records of your original cost basis, all distributions, what portion was ROC, and all reinvestments. It can get complicated after several years of ownership.

I keep hearing everyone talk about ROC, but my ET K-1 last year had like 6 different categories of income! Part was ordinary business income, part was ROC, part was interest, and there were some others. Do I need to track all of these separately??

Great question! I went through this exact same confusion when I started investing in MLPs. Here's what I learned after making some mistakes my first year: When you reinvest MLP distributions, you're essentially doing two separate transactions: 1. **Receiving the distribution**: This reduces your cost basis by the ROC portion (say 25¢ out of your 30¢ distribution) 2. **Reinvesting**: You're buying new units at current market price with that 30¢ So your original shares have their cost basis reduced by 25¢, but you now own additional shares with a cost basis of 30¢ (whatever the market price was when you reinvested). The key is tracking each "lot" of shares separately. Your original purchase is one lot, each reinvestment creates a new lot. This becomes really important when you eventually sell, because you can choose which lots to sell first for tax optimization. I highly recommend setting up a spreadsheet or using portfolio tracking software that can handle multiple lots. Don't try to average everything together - the IRS wants you to track each purchase separately. Also, make sure to save every K-1 form you receive, as you'll need the historical data to calculate your adjusted basis when you sell. One more tip: consider whether you really want to reinvest automatically. Some people prefer to take the cash distributions and manually reinvest to have better control over timing and record-keeping.