IRS chief counsel advised in a recent memorandum, ILM 201517006 (October 9, 2014), that an MLP incentive distribution right (IDR) restructuring was not a taxable exchange.

Modern MLP partnership agreements typically include IDR “reset” provisions that allow the IDR holder, normally the general partner, to reset minimum quarterly distributions and incentive distributions at higher levels in an effort to reduce the MLP’s cost of capital by reducing cash paid on the IDRs.

This MLP’s older form partnership agreement did not include specific IDR reset provisions. Instead, the MLP amended its partnership agreement and the IDR holder “exchanged” old IDRs for new IDRs with target distributions based on new minimum quarterly distributions and a specific number of common units intended to provide aggregate distributions roughly equivalent to the recent IDR distribution amount. 

The chief counsel memorandum concludes that the IDR reset was a readjustment of partnership items among existing partners and not a taxable exchange, and that a contemporaneous revaluation or “bookup” event permitted the MLP to allocate unrealized gain without a taxable capital shift. Although not binding or precedential, we believe the chief counsel's advice is clearly the correct interpretation of the law and confirms the longstanding position taken by many taxpayers.