A master limited partnership, or MLP, is a security issued by a partnership in the style of company stock. These securities were created by the Tax Reform Act of 1986 which allowed companies with primary business activities in real estate, commodities or natural resources to issue shares of their partnerships to the public. As the shares represent an interest in the partnership, any income from these products is considered a partnership distribution and taxable as such. Purchase MLPs within your Roth IRA to produce great returns, but be aware of the special tax rules on these investments, especially when shares are held within a retirement account.
MLPs became very popular among average investors when interest rates hit historic lows, as their high yields were attractive. When owning MLP shares, the company does not pay corporate income tax but instead distributes income to partners or unit holders. This becomes taxable income to the unit holder. When held within a retirement account, this income, if it totals over $1,000 for the unit holder, is considered unrelated business taxable income, or UBTI, for the account and is subject to tax even while in tax-deferred or tax-free accounts.
Therefore, if you own MLP shares within your Roth IRA, you could owe taxes on income from the company, even if you do not take a distribution from the account. Carefully evaluate this scenario with a tax advisor to determine if holding the shares within your Roth IRA is in your best interest. If you are interested in exposure to MLPs in your Roth IRA but want to avoid the possible tax headache, consider investing in an exchange-traded product that tracks MLP performance.
Silber Bennett Financial, Los Angeles, CA
Yes, you may own MLPs in your Roth IRA, but there are some potentially unfavorable tax consequences to doing so. IRAs are subject to taxes on a special type of income called unrelated business taxable income, or "UBTI." The distributions paid by MLPs are likely to be considered UBTI. If a Roth IRA earns more than $1,000 of UBTI annually, the UBTI income above $1,000 is subject to tax even if the securities are held in a retirement account, which are typically not taxed. If your retirement account earns more than $1,000 per year in UBTI, you have just eliminated the tax advantage of your retirement account. It is usually a good idea to hold individual MLPs in a taxable account versus a retirement account.