I’ve always avoided MLP investments due to the potential for tax issues if not tracked properly.
I believe the standard advice is never to put them in an IRA because some taxes are required anyway (return of capital?).
But what about in a Roth? If no taxes are due for any investment in a Roth, does that eliminate any tax issues for MLPs?
In an IRA its considered UBTI (Unrelated Business Taxable Income). You are allowed up to $1000 after deduction of expenses, but after that its taxable. Some custodians will force you to file a return and bill you if you don’t.
Thanks, I’ll go back to ignoring them…
Found publication 598 that states explicitly that UBTI is taxable within a Roth.
I guess I understand why it would be taxable as revenue to the business. I guess the MLP doesn’t pay the tax (like a C-corp would) so the owners must pay it individually.
Nope. In any type of IRA (Roth or Traditional), MLPs have the potential to generate UBTI (Unrelated Business Taxable Income). Your IRA (not you) must file it’s own tax return (generally the administrator does this and they can charge you for the filing) when the UBTI exceeds $1000. The taxable income from an IRA is taxed at the higher trust rates, with no standard deduction.
Exceeding $1000 in UBTI may not occur while you are holding the MLP, but it often happens when you sell the MLP because recaptured depreciation is UBTI. The thing about recaptured depreciation is that because you held the MLP in an IRA, you didn’t get any benefit from the depreciation. However, you are charged income taxes on the recapture of that depreciation when you sell.
And it’s not always just when you sell. If an MLP restructures from a partnership to a corporation (see Kinder Morgan restructuring in 2014), the change in investment is considered to be a sale, which will generate UBTI in the IRA.
I would also point out that even if you don’t sell the MLP while you are alive, your or your spouse’s non-spouse beneficiary will have to fully distribute the IRA (selling the MLP) within 10 years.
So it’s generally best to not hold MLPs in an IRA. I would also point out that holding rental real estate in an IRA can generate UBTI because of depreciation recapture - similar to MLPs.