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Enterprise Products Partners L.P. Message Board

  • lisahuang54321 lisahuang54321 Apr 11, 2012 5:47 PM Flag

    question for abter - general MLP purchase question

    or the folks on the IV MLP board if someone wants to cross post...

    We know that once your distributions exceed your basis they will start to be taxed.

    Let's say I want to buy an MLP. What if I sell puts far in the money such that they are bound to be exercised? The premium for the puts will likely be slightly more than the amount the strike is in the money. So when the puts are exercised the actual purchase price of the units will be very high however it is offset by the put premiums bringing the actual net cost close to or maybe slightly less than the market price.

    As I understand it the proceeds from selling puts which are exercised is as follows "no capital gain at time of exercise, proceeds deducted from cost basis of shares purchased". So I wouldn't have to pay tax on the put proceeds now, rather I should consider it as lowering my cost basis.

    But would that really wind up being part of the cost basis used by the MLP in the capital account? My suspicion is not. So this might be a way to buy units for the current market price but to artificially create a high starting capital account meaning that it would take much longer to reach distributions in excess of basis.

    I have never tried this, just thinking whether it would make sense in future for MLPs I might want to buy with the intent of holding a long time.

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    • This works as long as you can manage the option premium gains\losses as short term capital gains\losses.

      if I get assigned the K1 shows my basis at my strike price. This recently happened to me with etp, bought at 55, from puts I wrote way back when etp was over 55, and just got assigned last month! Just in time since the etp I bought in 2008 has used up almost all of its basis.

      This happens to be in an account with a large bank of long term capital losses from 2008, so there were no taxes paid on the put premiums. Worst case is I have swapped immediate short term cap gains for deferred ordinary income taxes.

      • 1 Reply to purplespyderman
      • "if I get assigned the K1 shows my basis at my strike price."

        OK, that's good so far and what I expected.

        "This works as long as you can manage the option premium gains\losses as short term capital gains\losses."

        But here's where the real advantage comes in. Isn't it the case that if you are assigned then your put proceeds simply lower your basis (although not the basis the MLP used for the capital account) and so you do not actually pay tax on them until you sell the position.

        "Worst case is I have swapped immediate short term cap gains for deferred ordinary income taxes."

        If that is the situation then I do not consider it an advantage. But if your put proceeds can simply factor into your basis and thus also be deferred indefinitely then doing this has the potential to become a real tax advantage. The key is whether put proceeds when assigned are taxable in the assignment year or whether become part of your basis. If the former then idea is no advantage, if the latter then it definitely is. And references I have seen say they become part of your basis rather than immediately taxable.

    • It seems your main goal is to hold an MLP for a very long time and delay the eventual tax implications that start once the distributions you've received have roughly equaled your original cost basis.

      Another way to do this is to just keep reinvesting your dividends. Your cost basis goes down with each distribution, but then goes back up with the reinvestment. They basically cancel each other out (with minor changes do to the passive gains/losses).

      I've done this with most of my MLPs in 2010 and 2011, and found my current basis is close to my original basis when I purchased (after factoring back in the accumulated passive losses that will be reclaimed).

      With reinvestment, at this rate I think 30 years can go by without having any tax owed (except for the occational passive gain). And all that while these MLPs keep growing and my ownership keeps compounding. I'm in my 30s and my spreadsheets show a very nice retirement by my 60s at this rate...

    • Sorry but this is basic tax 101. If you don't recognize gain on cash received (the amount of the puts premium) you can't add the amount to basis so as to avoid or reduce subsequent gain on the asset in question.

      Your term "artificially" accurately describes this dodge.

      • 2 Replies to bupers66
      • I think you missed the point.
        The critical factor is what information the MLP gets regarding your purchase. If they only know the strike/exercise price then you will be given a much larger initial capital account to work down and will delay the time at which you would be liable for distributions in excess of basis.

        If you can do that AND not pay tax on the puts premium in the year they are exercised (because you are using them to reduce your cost basis) then it appears to be a way to game the tax system.

      • I think your question has been answered. I do not buy or sell options on my MLPs because of the tax consequences.

        Generally limit myself to covered calls and overall market puts to cover another 2008/9.


    • Lisa: I have done exactly that.

      In the fall of 2010 I sold my entire MLP portfolio. During the next several months I systematically reacquired (with some edits) the entire portfolio using deep-ITM puts. As expected, I was assigned on all the shares except EVEP which consistently ran away from me. Of course, I make out OK on that, as you know.

      However, I claimed all the option income on 2011s return and kept my basis high on the MLPs deliberately. I didn't think the MLPs would factor in the put premium in calculating my basis. I still don't think that.

      • 2 Replies to phughyoung
      • "However, I claimed all the option income on 2011s return"

        Well that would defeat the purpose of my proposition. My understanding is that the premiums on exercised (assigned) puts is not taxed in the year they are sold or exercised, rather subtracted from the basis in the acquired investment. If you pay tax now on the put proceeds that would defeat the intent of avoiding tax on distributions in excess of basis later on.

        What I am thinking is if I intend to hold units for a long time (or forever) and I do this and do not pay tax on the puts premium now (because I am using it to reduce my basis), then I essentially increase the tax deferral of my MLP investment (assuming the MLP only knows about the strike/purchase price unadjusted for options premiums).

        P.S. Can you confirm whether the capital account on your K-1 reflected the strike price without factoring in put premiums as PSHONORE suggested. Like you, I doubt the MLP gets information about the put premium so I would expect it to reflect the strike price of the option.

      • Assuming you bought in 2011, it should not be hard to determine. Just look at your 2011 K1 and see if the K1 Capital Contributed (Box L) equals the "strike price" of the put. There are some differencs of opinion on what the brokers report to the MLP. One school of thought says they report the purchase date and the MLP uses the average price for that day. Others have a different opinion. Logicically I would not think the MLP would want units to have an inflated basis but I have no idea what they get. (And I have little expertise in Option trading for that matter)

        Think what would happen in this situation; if you sold a put and there was a sharp drop in price and you got exercised. Would you want your basis on the units you now own to reflect the strike price or the market value on the exercise date?

    • I meant question for arb...

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