MLP distributions are not dividends. They reduce your basis year after year until reaching zero — then distributions become immediately taxable.
When a stock pays a dividend, you owe tax that year but your cost basis stays the same. MLP distributions work differently. Under IRC §733, cash distributions reduce your partner basis dollar-for-dollar. A typical midstream MLP yielding 7–8% will reduce your basis by roughly 5–8% of your original cost each year after accounting for income allocations.
For many midstream MLPs, distributions exceed taxable income, causing a steady basis decline. After 8–12 years, your adjusted basis may approach zero. At that point, under §731, distributions in excess of basis become immediately taxable as capital gain — even though you haven’t sold a single unit.
Lower basis means higher gain when you sell. If you paid $25/unit and your adjusted basis is now $8/unit, your taxable gain on a $30 sale is $22/unit — not the $5 your broker reports. Plus, part of that gain is ordinary income under §751.
Bottom line: MLP distributions are tax-deferred, not tax-free. The tax is deferred into your basis, creating a larger taxable event when you sell or when basis reaches zero.