This from Howard Hinds of the Curbstone Group in Boston:
Master Limited Partnerships (MLPs) are excellent tools for estate planning:
1. MLP distributions (around 8% yield right now) are considered return of capital, meaning that distributions reduce your basis in the MLP, while allocated net income increases your basis.
2. Tax Shield: Because MLPs own large hard assets (like pipelines) with high depreciation (non-cash) expenses, allocated income to an investor is usually less than 20% of cash distributions in a given year for the first several years of ownership. This creates a tax deferral, which is recaptured when you sell the MLP.
3. When you sell an MLP: (a) the gains from your purchase price to selling price are taxed at capital gains rates, and (b) the difference between your purchase price and your basis (which has been reduced over time) is taxed at ordinary income rates.
4. But, if you die while holding an MLP, the tax deferrals you have accumulated over time are washed away along with the capital gains taxes, and whoever receives those MLPs after you die has a new stepped up basis, so those tax deferrals are not passed along. This can be a very big deal for someone who has owned Kinder Morgan Energy Partners since 1995 and they have $0 basis and the share price is $55 per share
So in addition to being great income vehicles for someone with large estate, MLPs can be great tax shields as well.