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Dear Tax Talk,
I have shares/units in a master limited partnership, or MLP, in an IRA. This MLP will be acquired by another company and the shares will be converted into the shares of the buyer. Will I owe tax on the transaction? Thank you.
Because IRAs grow tax-free, this means generally the IRA does not report any tax gains and losses during the time funds are maintained in the account. This would include the conversion of the MLP shares/units held by your IRA that are converted into shares of a new company. However, there is an exception if the MLP has “unrelated business taxable income,” and if this is the case then the IRA may owe tax.
“Unrelated business taxable income” is generated by tax-exempt organizations when they have a business that is not related to their exempt purpose. If the exempt organization is an MLP, then the share owners will owe the tax. In this case, it would be your IRA.
What is a master limited partnership?
Like stocks, MLPs trade on an exchange, but investors buy units of partnership rather than stock shares.
Most MLPs are in the energy business, particularly in natural gas pipelines.
These investments have tax advantages, but if they’re held in an IRA, you might have to pay tax on unrelated business taxable income, or UBTI, even though IRAs are supposed to be tax-advantaged retirement accounts. This is in addition to paying tax at the time you take distributions from the IRA.
If you have a traditional IRA, your contributions are generally tax deductible. This is known as “tax deferral.” Hopefully by deferring your income earned at higher tax rates to the future, your income may be taxed at lower rates when it’s time to take distributions. All distributions are includible in your income and reported on your tax return in the year you receive them.
Roth IRA contributions are made with after-tax dollars, which means no tax deduction is allowed for the year of the contribution. However, the good news is that in the future, distributions are received tax-free if you meet all the requirements.
Any way you look at it, IRAs are a wonderful way to save for your retirement and lower your taxes. However, don’t forget there are rules regarding distributions, and penalties can apply if they are not followed. For instance, taking a distribution before the age of 59 1/2 years of age can create an additional 10 percent tax unless certain conditions exist.
Thanks for the great question and all the best to you.
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To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.