Two tax questions. I just want to make sure I understand these concepts.
For the purposes of these questions: A)Let the cost of units = $10,000 B)Let the value of units = $18,000 C)Units are held for over 1 year
1) In a sale event (all units sold), if my cost basis is exactly zero or negative, what are my tax consequences using the above info? My understanding is my $8,000 of capital gains is taxed at LTCG rate (15%), and the rest ($10K) is taxed at ordinary income rates.
2) If my cost basis is $0 and I'm still holding all my units, what is the tax treatment for my next distribution?
No time limit (to the best of my knowledge). Also remember that once your basis gets to $0, there are no further losses booked and distributions are txbl as LTCG. (It may be sooner than you think with MLPs like KMP and EPD)
I think the depreciation recapture is a little more complicated. Partnership acct'g and tax regs "ain't easy"
I thought I'd add some comments here for discussion purposes. I'm not sure that I am correct. Maybe I can learn something, or someone else can.
First, how could you get a negative basis in the MLP? Once you reach zero, any further distributions are taxed?
Second, if you sold for $18,000 and had a zero basis, the entire $18,000 gain would be taxed as a long-term capital gain, except to the extent that there was depreciation recapture, which is taxed at ordinary gain rates (whatever your tax bracket is).
When you sell a partnership interest the tax rules require that the sale be treated as if you sold the physical assets of the partnership (rather than just selling the intangible common MLP units). Pass thru works both ways.
To the extent that favorable accelerated depreciation was claimed on the depreciable assets, when those assets are sold the IRS does not want you to also get favorable taxation on the gain as well. You ran your cost basis lower faster because of the accelerated depreciation, so you'd be getting a double benefit if you were only taxed at capital gains rates on the gain. Thus the recapture to the extent that accelerated depreciation was claimed on the physical assets deemed sold by you.
The more we think and write about this subject, the better we will know it.
When you sell KMP stock it is taxed the same as any other stock. What is different is the K-1 tax aspect. For example, I own 10,000 shares of KMP and have a K-1 carryover loss (form 8582) of $200,000. When I sell all of this stock I will have a long term capital gain of $250,000 (taxed at 15%), and I then can use my $200,000 loss carryover as an ordinary loss. Great tax deal!
Yours is a straightforward question, but a relatively complex answer that depends on several factors you didn't mention yet.
The BEST way to do this for KMP is to use an online calculator set up by the company that helps KMP (and the majority of energy MLPs) with their K-1s each year. What their online calculator does is using YOUR K-1 info from 2010 (which they have...you have to register for free and log into their system), the calculator gives you a pretty darn good tax situation analysis IF you had sold on 12/31/2010. Changes since then (e.g., the additional distributions you got, the amount of depreciation, new investments, depletion allowances and income that wen on with your pieces of the KMP partnerships) all will change your specific tax outcome from what the calculator can show. If you owned KMP for 15 years, missing the past 9 months is not so bad. If you owned for 15 months, missing the past 9 months makes it less useful. The website is www.taxpackagesupport.com.
Without the help from that calculator, it is almost impossible to make a good tax situation analysis. Among other problems is that your tax basis (as calculated for a regular stock corporation) has no direct bearing on your taxes if you sell an MLP. What is important is the amount of invested capital you have that is showing on the Partnership's books. They tell you that each year on your K-1, but there is no way an individual can keep track of that themself. There is too much internal-to-the-partnership accounting that goes into their tracking of your invested capital level. If you have made multiple purchases, including reinvesting distributions, it gets even more complex.
If you feel you must have a rough ballpark guesstimate of your tax situation, I would consider the following: 1) you have not yet been taxed on all the distributions you received so far. Sum them all up, and assume you will pay tax at your marginal income tax rate (NOT LTCG). In fact you already paid tax on a small bit (<5%) of the distributions you got each year...the parts that were declared to be interest or qualified dividends...but that is down in the level of noise. 2) as you suggested, treat the difference between your net sale proceeds and your net purchase cosst as a LTCG, and calculate tax accordingly.
This simple 2 step process is very crude, and doesn't really capture all the important issues in selling an MLP. But it is the best you can do.
When you do sell, by the way, that year's K-1 will have almost all the info you (or your accountant) need to do your taxes. The only things the K-1 wont have is (a) the exact price you bought and sold for...the K-1 uses a weekly or monthly average price, and (b) the commission costs you paid. Along with the K-1s from previous years, you will have everything you need.