Yes, you can purchase shares in a master limited partnership, or MLP, for your Roth IRA, but you'll need to be aware of the special tax rules on these investments. The rules become especially tricky when you hold your shares within a retirement account.

Key Takeaways

  • Master limited partnerships (MLPs) often pay attractively high yields.
  • You can hold MLP shares in a retirement account, such as a Roth IRA.
  • But unlike other IRA investments, MLP income can be immediately taxable if it reaches $1,000 or more.

How Master Limited Partnerships Work

A master limited partnership is a security issued by a partnership in the style of company stock. These securities were made possible 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. MLPs became popular among average investors when interest rates hit historic lows, making their relatively high yields attractive.

How Master Limited Partnerships Are Taxed

Because the shares of an MLP represent an interest in the partnership, any income they produce is considered a partnership distribution and is taxable as such. A company that issues MLP shares doesn't pay corporate income tax, but instead distributes income to its partners or unit holders. This becomes taxable income to the shareholder.

When you hold MLP shares within a retirement account, such as a Roth IRA, this income—if it totals $1,000 or more—is considered unrelated business taxable income, or UBTI. That makes it subject to immediate tax, unlike most other investments you might hold in an IRA, where your earnings are usually tax-deferred or, in the case of Roth IRAs, tax-free.

If you want MLP exposure in your IRA, while avoiding immediate taxes, consider an exchange-traded fund that tracks MLP performance instead.

If you're tempted to buy shares in an MLP for your IRA, either a Roth or traditional one, it's worth consulting a tax advisor to work through the tax implications. If you are interested in exposure to MLPs in your Roth IRA but would rather avoid the possible tax headaches, consider investing in an exchange-traded product that tracks MLP performance. Or, as an alternative, buy the MLP shares for a regular, taxable account.

Advisor Insight

Rebecca Dawson
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 $1,000 or more 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 $1,000 or more 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.