Your revocable trust holds MLPs. While you're alive, that's fine — tax-invisible. The day you die, your successor trustee faces a decision that can cost your heirs $14,000 over five years. Here's the math, the mechanics, and what the trustee needs to do on Day 1.
By Lucas Andersen — Masters in Finance, proprietary energy trader, direct MLP holder (Washington state)
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Key Takeaways
My MLPs are held in a revocable living trust. Yours probably are too. While I’m alive, this changes nothing about my taxes — the trust is invisible to the IRS under §§671–679. The problem is the day after I die: the trust becomes irrevocable, and my successor trustee inherits MLP positions inside a structure that suddenly faces trust-rate compression, potential UBTI, and K-1 administrative costs that didn’t exist 24 hours earlier.
I’ve run the numbers for a canonical 5-MLP portfolio (EPD, ET, MPLX, WES, PAA at standard sizes) across three trustee options over the first 5 years after death. Distribute-to-beneficiaries beats hold-in-trust by $14,288 over 5 years. For the broader argument, see When Step-Up Basis Beats a Trust. This article is about what happens inside the trust you already have.
A revocable living trust is a grantor trust under IRC §§671–679. K-1s report to your SSN, basis tracking is unchanged, §199A applies normally, no UBTI, no Form 1041. §1014 step-up is preserved because revocable trust assets are in the gross estate.
The trust becomes irrevocable, gets its own EIN, MLP basis resets to FMV under §1014(a), accumulated §751 recapture is eliminated. The trustee then chooses: (A) Distribute units to beneficiaries — units move to each beneficiary’s individual account at stepped-up basis, K-1 income taxed at individual rates (22–32%). (B) Hold in the irrevocable trust — trust-rate compression (37% top bracket at ~$15,000), potential UBTI under §512, multi-state Form 1041 filings (ET alone has 40+ states), $2,000–$5,000/year in K-1 admin. (C) Sell at step-up — FMV minus stepped-up basis ≈ $0 gain, tax-free liquidation. Most trustees default to Option B because doing nothing feels safest. It’s usually the most expensive choice.
| Line item | Option A (Distribute) | Option B (Hold in Trust) | Option C (Sell at Step-Up) |
|---|---|---|---|
| Tax rate on ordinary | 24% indiv. | 37% trust | n/a (sold) |
| 5-yr distributions | $39,427 | $39,427 | $0 |
| 5-yr federal tax | $1,746 | $2,534 | $0 |
| 5-yr total costs | $4,746 | $19,034 | $0 |
| Net cash after costs | $34,681 | $20,393 | $195,695 |
| Yr-5 portfolio FMV | $232,425 | $232,425 | $0 (sold) |
Option A beats Option B by $14,288 over 5 years — most of that gap is trust admin cost (multi-state filings + $2,500/yr trust CPA), not the federal rate differential (which grows larger in years 10+). Option A also retains $232,425 in appreciated MLP units at Year 5.
Within 30 days of death: (1) Obtain an EIN for the trust (irs.gov, 10 min). (2) Determine stepped-up basis for each MLP position — closing price on date of death times units. (3) Contact the broker and correct cost basis; brokers frequently carry forward the decedent’s eroded basis. (4) Decide: distribute, hold, or sell. (5) If distributing, coordinate with each beneficiary’s broker in writing. (6) If holding, budget $2,000–$5,000/year for trust K-1 administration and read Section 6 on §663(b). (7) File year-of-death K-1s correctly — pre-death income on decedent’s final 1040, post-death on the trust’s 1041.
The MLP issues one K-1 for the full calendar year. The CPA must allocate every box (income, distributions, liabilities, §199A data, state-source info) between the decedent’s final 1040 and the trust’s 1041 using daily proration under §706, interim closing of the books, or specific identification. For 5 MLPs: 10 K-1 allocations plus split-year state filings. For ET: 3 entities × 2 returns × 40+ states. Use a CPA experienced with death-year partnership allocations.
Under §663(b), a trustee can make distributions within 65 days after year-end and elect to treat them as if they happened in the prior year. The trust deducts DNI, beneficiaries report the income at individual rates, and trust-rate compression is retroactively unwound. The election is made on Form 1041 by checking the §663(b) box; it is not automatic. For a trust holding MLPs under restrictive distribution terms, this is the pressure-relief valve.
Mitigations: (1) Distribute income not principal — most trusts restrict principal but allow annual income distributions deductible as DNI. (2) Use §663(b) to retroactively distribute. (3) Check HEMS discretion for in-kind unit distributions. (4) Consider in-kind distribution of specific assets if trust terms allow. (5) §645 election: qualified revocable trust can be treated as part of the estate for up to 2 years post-death, enabling a fiscal-year Form 1041 as a bridge.
After the first spouse’s death in a community property state, all units step up to FMV — the surviving spouse holds positions with a completely fresh basis. Distributions resume, ROC erodes basis again, and at the second death §1014 applies again for the next generation. The cycle runs cleanly inside or outside a trust.
Community property states (AZ, CA, ID, LA, NV, NM, TX, WA, WI): under §1014(b)(6), BOTH halves of community property step up at the first spouse’s death. For 1,000 EPD units at Year 15 (FMV ~$62,826, eroded basis ~$3,500): common-law half step-up gives a new basis of $33,163; community-property full step-up gives $62,826. Additional step-up in a CP state: $29,663, eliminating roughly $7,238 more in federal tax than the same position in a common-law state.
Probate avoidance, incapacity planning, privacy, multi-state property consolidation. The trust is the right structure for most MLP holders — §1014 step-up is preserved. The only addition needed is a specific written instruction to your successor trustee about Day 1.
Coming soon: What happens when a US revocable trust holds MLPs and the beneficiaries are Norwegian residents — treaty implications, FATCA reporting, and dual filing requirements.