How to handle a conversion of a stock to MLP with both 1099 and K-1s generated

[poncho_mike]

In late 2018, I bought 100 shares in Macquarie Infrastructure for $3707.  This stock was a spin-off of a larger company that provided service to airports and aviation (fueling, etc).  In 2020, the company decided to sell off the businesses it owned and eventually cease operation.

In January 2021, one of the businesses was sold off and a $1100 dividend was paid out.  That dividend consisted of a $567 return of capital and a $532 qualified dividend.  By my calculations, the basis would now be $3138.  The $532 was reported on my 1099 as a qualified dividend.

In October 2021, the company sold off the largest of the assets and converted to MLP.    I received $3560 in cash and 100 shares of the MLP, which continued trading using the same ticker symbol.  The closing price on the day of the conversion was $3.71 a share, total of $371.

I was also issued a K-1 for October thru December 2021.  There was a $179 qualified dividend reported on my K-1.  My brokerage 1099 noted the $3560 distribution, but did not categorize it as a qualified dividend or return of capital.

I'm trying to understand how to treat the October conversion from a stock to MLP.   I think that upon conversion to the MLP, I incurred a capital gain.  The following statement is from my K-1 regarding the tax treatment.

A unitholder (including a unitholder who sold his/her units after the cash distribution record date of October 4, 2021) who received a portion of that cash is treated as having sold the majority of his/her Macquarie Infrastructure Corporation common stock contributed in the merger in exchange for the cash distributed (a “disguised sale”). Unitholders who received their units in the merger generally would have taxable gain or loss in an amount equal to the cash received less such holder’s U.S. federal income tax basis in the shares of
Macquarie Infrastructure Corporation common stock deemed to have been sold.

So neglecting qualified dividends, I see three ways to report this.

Method 1:  I have a net capital gain of $420.  (3560 + 567 - 3707)  I have zero basis in the new MLP.

Method 2:  I have a capital gain of $791 (3560  + 567 + 371 - 3707).  This assumes the basis in the MLP is the value the first day of trading.

Method 3:  The basis after the Jan 2021 distribution was $3140 (3707 - 567). 

The total value of the transaction was $3931 (3560 cash plus stock worth $371).

I ratio'd the MLP and the cash (90.56% cash, 9.44% was the MLP). 

I calculate the basis for the sale of to be .9056 x 3140 = $2843.  This gives me a capital gain of $716.

The basis in the MLP is .0944 x 3140 = $296.

There are some issues with all these approaches.  My brokerage shows the 100 shares of the MLP have a basis of $3140.  I plan to call them tomorrow.  The second is the company put out a news release right before the conversion and made the statement "the fair market vale of the MLP is estimated to be $3.25 per share", with the final determination to be made following the closing of the sale.   That is where I got the $3.71, as that was the first day closing price after conversion to MLP.

I'd appreciate some feedback on which method I should use.

Thanks.

[nexchap]

Method 2 looks closest.  The best way to think about this is as two separate transactions:

1. You sold all shares of Macquarie.  You'd report the Cap Gain as appropriate.
2. A minute later, you purchased 100 shares of the new MLP.

For 1, your cost basis is the $3,138 you calculated.  Your proceeds are $3,560+the value of the 100 shares.  While closing price on the first day of trading is likely close to the correct value for the shares, the partnership should be able to tell you the exact value to use.  You may even be able to use the opening K-1 they provided: in Part II, Section L, "Beginning Capital Account" should be 0, and the next line will show "Capital contributed".  "Capital contributed" is likely the value of the 100 shares.  But again, the partnership should confirm.  There may be info on how to contact them on the K-1.  Otherwise, you could contact them directly (e.g., through Investor Relations).

Once you have the correct basis, you may want to have your broker update the basis they show.  But this is optional since MLP's are "non-covered" and the broker's basis isn't considered accurate.

[poncho_mike]

Nexchap, thanks for your help.  You also helped last year on a MLP question.

The K-1 was confusing.  As you said, the Beginning Capital Amount for 2021 was zero.

There is a  line item "Capital contributed during the year", which is $191. 

There is a line item "Current year net income (loss), which is $177.

These two values come to Ending Capital Account, which is $368.  This is very close to the $371 that was the closing price on the first trading day as an MLP.

On the same date as the conversion, the MLP immediately paid a $179 qualified dividend, which is shown on the K-1 in lines 6A and 6B.

I'm getting various opinions on the reportable transaction.  I talked to someone at Turbotax help, who stated options 1 & 2.  I have a friend who is a retired CPA, and he came up with option 3.  I have a call into my broker to discuss adjusting the basis.

What date is the Ending Capital Account valid for?  I assumed it would be the end of 2021, rather than the value associated with opening the account.

Again, thanks for the help.

[nexchap]

@poncho_mike The ending capital account is as of 12/31.  

I assume that the K-1, in addition to the $179 dividend, also had some other entries that total -2?  That would explain the $177:  the "Current Year net income (loss)" is always a total of the items on the K-1 that impact taxes.

That makes the $191 the starting basis for those 100 shares, which I can't explain. 

I suggest contacting the K-1 preparer, or the partnership (investor relations will have an email address on their site), or both, to get documentation of the starting value of those shares.  Once you have the documentation, the K-1 itself may need to change (it's possible the 191 is an error).

As to method, I'm not a CPA so if you get different advice from someone who knows some nuance of the code that I'm missing, ignore me.  But I don't like method 1 because it allows you to delay reporting a CG:  by arbitrarily setting the value of the shares to 0, you reduce CG today and pay more in the future.  Since you don't have a justification for setting the share basis to 0, that seems questionable.

And method 3 is going to imply a basis for the MLP shares that, again, may not match what the partnership tells you they're worth.  So again, a conflict.

So that's how I got to method 2, using whatever the correct MLP starting basis is.

[poncho_mike]

@nexchap , There was a box 13 expense of $2 in addition to the $179 dividend.

I finally received a call back from the partnership.  They stated my basis would be the Capital contributed during the year, which was $191.   I'm not sure how they arrived at that number, but I will use method 2 and recalculate using the basis of $191.

Thanks again.