How REIT, BDC and MLP Payouts Are Taxed

REITs, BDCs and MLPs pay some of the biggest regular payouts in the market, and each has tax rules of its own. If you hold them in a taxable account, those rules can take a meaningful bite. Here’s how each works.

Why they’re different

An ordinary company pays corporate tax on its profit, then pays dividends from what’s left. The lower qualified dividend rate partly reflects that the money was already taxed once. REITs, BDCs and MLPs mostly avoid corporate tax on the income they pass through. So their payouts generally don’t get the qualified rate, and are taxed as ordinary income or under special rules.

REITs

A REIT’s distribution can include up to three parts, each shown on your Reading Your 1099-DIV:

The big help is the Section 199A deduction: you can generally deduct 20% of qualified REIT dividends, so only 80% is taxed.

BDCs

BDCs earn mostly interest on loans, so most of their dividends are taxed as ordinary income. A small part can be qualified (from equity stakes in companies) and some can be capital gain distributions. Under long-standing rules BDC dividends don’t get the REIT style 199A deduction, though Congress has considered extending similar relief, so check the current year’s rules. With yields around 10%, the tax drag in a taxable account is significant.

MLPs: partnerships, not companies

Master limited partnerships, mostly pipeline and energy infrastructure businesses, are taxed as partnerships. When you buy units, you become a limited partner. That changes everything:

• You get a Schedule K-1, not a 1099. It reports your share of the partnership’s income and deductions and often arrives in March or later.
• Most distributions are return of capital, because depreciation offsets much of the partnership’s income. You pay tax on the (usually small) income allocated to you, and your basis falls with each distribution.
• When you sell, part of your gain is taxed as ordinary income (recapturing those earlier deductions), the rest as a capital gain.
• State returns: MLPs operating in many states can create filing requirements in some of them.
• Qualified publicly traded partnership income can also get the 20% Section 199A deduction.

Alternatives that send a normal 1099: pipeline companies organized as corporations, and MLP funds structured as corporations such as AMLP, which pay corporate tax inside the fund and send you a 1099. Simpler paperwork, at the cost of that fund level tax.

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