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Author: TMFBreakerRob Big gold star, 5000 posts Old School Fool Home Fool Supernova Phoenix 1
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Subject: MLPs in IRAs Date: 8/8/2010 1:33 PM
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We're having quite a discussion on this over at Rule Breakers and Income Investor and I'm hoping someone here can shed some real light on the subject of holding MLPs within IRAs.

MLPs annually provide a K-1 statement that lists Unrelated Business Taxable Income (UBTI), among other things. If an IRA earns UBTI exceeding $1,000 it must pay income taxes on that income.

This is a typical article indicating that an investor holding an MLP in an IRA just needs to look at the K-1s and make sure they total less than $1000 to avoid a taxable event...and if it is exceeded, it is merely added paperwork and a tax on the amount over $1000:
http://www.mhinvest.com/supportArticles/MLP-IRA.pdf
Typically, most MLPs generate very little UBTI or even negative UBTI, making this issue appear to be moot. Happy days! ;)

This is an opposite view...and not so happy. :P

Here's what Investopedia has to say:

http://www.investopedia.com/articles/basics/07/ml_partnershi...

"Tax-exempt institutional investment funds such as pensions, endowments and 401(k) plans are restricted from owning MLPs because the cash distributions received are considered unrelated business taxable income (UBTI) - income that is unrelated to the activity that gives the fund tax-exempt status. This could create a tax liability on any distribution of more than $1,000. This is also true for individuals when holding MLPs in an IRA account; therefore, the best way to hold them is in a regular brokerage account."

And then here is from a FAQ at an MLP:

http://www.magellanlp.com/faqs.asp

Although tax-exempt accounts, such as an IRA, may invest in MLP units,

virtually all of the taxable income generated by a publicly traded partnership is considered to be unrelated business taxable income (UBTI).

As such, this income is currently taxable not only to IRAs but also Keoghs and other qualified retirement plans to the extent it exceeds a $1,000 annual threshold. Please consult with your financial advisor.


*****

Yuck! So....who to believe? Can I just total those K-1s and work to keep the stated UBTI under $1000, or do all or most of the distributions become UBTI within an IRA?

Please recognize that we're not looking at cases where someone may only have a few thousand dollars in MLPs in IRAs, but where one may have a million dollars or more there.

Thanks, folks!

Rob
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Author: OSUMAG Two stars, 250 posts Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110844 of 121585
Subject: Re: MLPs in IRAs Date: 8/8/2010 5:22 PM
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Hey Rob,

Typically, most MLPs generate very little UBTI or even negative UBTI, making this issue appear to be moot. Happy days! ;)

Unfortunately, the Miller/Howard Investments article is inaccurate. Luckily, they claim they are not tax professionals and it is for good reason. They are looking at recent K-1s showing tax losses and not understanding the entire picture behind these tax losses.

The past decade has been great for MLPs primarily due to bonus depreciation for tax purposes that allowed taxpayers to write-off over 50% of the asset costs. This bonus depreciation has expired this year and I expect people owning MLPs will be getting a rude awakening come this tax season and forward. These assets have very little tax basis remaining while there remains significant book basis to depreciate for financial statement purposes over the next few years. I would expect over the next decade that book depreciation will be much higher than tax depreciation giving the MLP owner large ordinary income on line 1 of the K-1 and the dreaded UBTI. I believe this could affect owners with as little as $5K invested in MLPs in an IRA.


Can I just total those K-1s and work to keep the stated UBTI under $1000, or do all or most of the distributions become UBTI within an IRA?

The problem with this approach is by the time you receive your K-1, it is too late for that year and the tax will be due.

Personally, I do not believe it makes any sense to hold a MLP in a tax-deferred account. I agree owning a MLP is a headache for tax purposes (We have not even got to potential state tax liabilities). Generally, the distributions are return of capital, which are tax-free and reduce your basis in the partnership. Most individuals could not write-off the taxable losses generated from the MLPs from the past decade; instead, these passive losses are suspended until the there is income or until the individual sells his shares of the MLP.

Let me know if anything was not clear.

Regards,

Michael

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Author: TMFBreakerRob Big gold star, 5000 posts Old School Fool Home Fool Supernova Phoenix 1
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Subject: Re: MLPs in IRAs Date: 8/9/2010 8:33 AM
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Can I just total those K-1s and work to keep the stated UBTI under $1000, or do all or most of the distributions become UBTI within an IRA? -- Rob

The problem with this approach is by the time you receive your K-1, it is too late for that year and the tax will be due.
-- Michael

Thanks for your response, Michael!

I left out a bit of background in my comment. The MLP board over at Investor Village has been collecting UBTI info for several years from folks who have been investing in a wide variety of MLPs. While there are certainly no guarantees, I was referring to using that historical data to target my investments toward those companies that are consistently running negative UBTI. But, that could change any year....its just the best I can do. :)

Personally, I do not believe it makes any sense to hold a MLP in a tax-deferred account.

I see your point, but most of my cash is in IRAs....and I like the nice cash generation and potential growth (distributions and capital gains) of MLPs. I can get great *dividends* from...say...REIT preferreds, but no growth in the amount disbursed. Ditto with various debt instruments that I find on quantumonline.com

I'm very close to retiring a bit before age 58 and will use a large chunk of my cash from taxable accounts to bridge me to 59 1/2...and have been planning on letting the IRA balances grow in the interim until I'm ready to withdraw.

On the other hand, I'm thinking of establishing a single MLP position in a taxable account to check out the tax filing issues on a trial basis. Hopefully, Turbo Tax makes it simple...er. LOL

I'm always open to listening to the wisdom of others though if you have further suggestions.... :)

Rob
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Author: OSUMAG Two stars, 250 posts Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110846 of 121585
Subject: Re: MLPs in IRAs Date: 8/9/2010 9:03 AM
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I left out a bit of background in my comment. The MLP board over at Investor Village has been collecting UBTI info for several years from folks who have been investing in a wide variety of MLPs.

Rob, I will have to check it out this evening. Do you have a link? Do they have data pre-2001?

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Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110847 of 121585
Subject: Re: MLPs in IRAs Date: 8/9/2010 9:35 AM
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I'm very close to retiring a bit before age 58 and will use a large chunk of my cash from taxable accounts to bridge me to 59 1/2...and have been planning on letting the IRA balances grow in the interim until I'm ready to withdraw.

Do you have a 401(k) with your current company? Retiring (ending service with your company) in or after the year you turn 55 would allow you to withdraw money from your 401(k) without penalty or having to take 72(t)/SEPP withdrawals. Assuming that you don't have your 401(k) invested in MLPs, you could use that the bridge to 59 1/2 without disturbing MLP investments in either your IRA or your taxable accounts.

If your 401(k) plan allows, you could even move some of your IRA money into your 401(k), if your current 401(k) balance isn't high enough for that bridge.

Personally, with the tax laws likely to be changing and the requirement for the IRA to have to file it's own tax return for UBTI > $1000, I would be cautious about investing a significant amount of an IRA into MLPs - the cost of getting the IRA to file the tax return alone (not really a DIY thing) has the potential to offset any advantages.

AJ

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Author: cgrinder Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110848 of 121585
Subject: Re: MLPs in IRAs Date: 8/9/2010 5:23 PM
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i will be 55 at the end of the year. we have a profit sharing plan for our retirement. it was started in 1967. we could retire at 55 according to the plan originally. then came along ira's. everyone now think's it got moved to 59 1/2.

any insight from anyone on this?
thanks! fred

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110849 of 121585
Subject: Re: MLPs in IRAs Date: 8/9/2010 5:40 PM
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i will be 55 at the end of the year. we have a profit sharing plan for our retirement. it was started in 1967. we could retire at 55 according to the plan originally. then came along ira's. everyone now think's it got moved to 59 1/2.

Employer plans and IRAs have different rules. See IRS Publications 575 and 590.

Phil
Rule Your Retirement Home Fool

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Author: OSUMAG Two stars, 250 posts Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110850 of 121585
Subject: Re: MLPs in IRAs Date: 8/9/2010 9:21 PM
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Rob,

I performed a quick search on CCH to see if there were any good tax strategies you may take with owning a MLP in an IRA. I did not find anything on point, but I did come across the following article, Energy-Related Master Limited Partnerships Present Investment Opportunities with Some Tax Complexity, (Apr. 1, 2004) by Richard B. Toolson, Ph.D., CPA in CCH’s TAXES – The Tax Magazine (I know, just as exciting as Us Weekly)

The article goes over the basics of owning a MLP and its advantages such as generous cash distributions and low price volatility. Toolson does recommend holding a MLP in a taxable account. However, I am attaching a section describing a possible solution. It might help if you do some hop-scotching with your various MLP investments. In other words, hold for a year, wait for the last quarterly distribution, sell, buy another MLP, and so on. You can buy the same MLP every other year. Since you own the MLP in an IRA, you do not need to worry about any depreciation recapture or capital gains on the disposition.

Emphasis added. Ignore references to the tax code.

Normally, MLPs make an election under Code Sec. 754, which allows an adjustment to the inside basis of partnership property equal to the difference between the partner's outside basis (generally the purchase price plus share of liabilities) and the partner's proportionate share of inside basis. 22 If the outside basis exceeds the partner's share of inside basis, an upward adjustment would be made to the partner's share of partnership property. 23 By the same token, if the outside basis is less than inside basis, a downward adjustment would be made to the partner's share of partnership property. 24 Code Sec. 755 prescribes the process for allocating the adjustment among the various partnership assets, including depreciable properties. This inside basis adjustment for partnerships extends to MLPs. As a result, assuming a Code Sec. 754
election is in place, the unit holder's share of depreciation deductions will be based on the fair market value of the depreciable property at the time the MLP is purchased and not on the partnership's adjusted basis in the property. Because tax depreciation rates normally will exceed the economic depreciation rates for MLP depreciable assets, new unit holders usually will receive a greater depreciation deduction than older unit holders. Typically, as the unit holder's holding period increases and less depreciation is passed through to the unit holder, less of the unit holder's cash flow will be shielded from taxation. At that point, the investor may want to consider selling the old MLP and reinvesting the proceeds in a new MLP that will be able to shield more of the cash flow from taxable income. Alternatively, if the investor wants to retain ownership in the original MLP, the investor might purchase additional units in order to receive a step-up in basis in the partner's proportionate share of depreciable property on the new units, with the result that a greater percentage of cash flow will be shielded from taxation.


Some food for thought… I cannot verify if it this strategy will work, but it may help reduce the likelihood of getting a big hit of UBTI. Please take my tax advice with a grain of salt.

As discussed in the previous post, I am worried about all the tax depreciation taken this past decade (primarily from bonus depreciation), so I expect higher taxable income and UBTI this decade. However, if the MLP is aggressively adding PP&E, the tax depreciation can still potentially be greater than book depreciation which should limit the taxable income. Of course, aggressive asset additions would subsequently reduce potential distributions to the partners.

Unfortunately, an investor cannot obtain adequate disclosure in the 10-K on potential deferred tax liabilities such as the difference in the book/tax basis of PP&E. For example, Magellan Midstream Partners, L.P. had approx. $500 million in net PP&E additions in 2009 (including acquisitions of businesses). Through the first half of 2010, they only have $100 million in net PP&E additions. Without bonus depreciation in 2010, they will not have the significant taxable losses as in the past, but they potentially may have enough tax depreciation to exceed book depreciation, which may keep taxable income low.

Good luck!

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Author: TMFBreakerRob Big gold star, 5000 posts Old School Fool Home Fool Supernova Phoenix 1
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Subject: Re: MLPs in IRAs Date: 8/10/2010 9:48 PM
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I left out a bit of background in my comment. The MLP board over at Investor Village has been collecting UBTI info for several years from folks who have been investing in a wide variety of MLPs.

Rob, I will have to check it out this evening. Do you have a link? Do they have data pre-2001? -- OSUMAG

I have a link:

http://www.investorvillage.com/smbd.asp?mb=5028&mn=10994...

but it only includes 2006-2008. There is probably data for 2009 as well, but I haven't searched for it.

Rob
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Author: TMFBreakerRob Big gold star, 5000 posts Old School Fool Home Fool Supernova Phoenix 1
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Subject: Re: MLPs in IRAs Date: 8/10/2010 10:00 PM
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Do you have a 401(k) with your current company? Retiring (ending service with your company) in or after the year you turn 55 would allow you to withdraw money from your 401(k) without penalty or having to take 72(t)/SEPP withdrawals. Assuming that you don't have your 401(k) invested in MLPs, you could use that the bridge to 59 1/2 without disturbing MLP investments in either your IRA or your taxable accounts. -- AJ

Now *that's* an interesting idea!

Yes, I have a 401k also, about 30% of our savings. I've shifted money from an assortment of "allowed" mutual funds to 100% company stock over the last year and a half. Yes, I know that is considered very poor form, but I happen to be in a position where I felt pretty confident that the stock would do pretty well and it has: Ford Motor.

Once it became apparent that GM wasn't going to stop building cars (and buying parts from suppliers), I was confident the industry wasn't going to implode, so I started loading up as things became clearer. Probably made the final purchases somewhere around $7 or so.

Anyway....that part is irrelevant other than to say I expect some additional significant upside over the next year...but would still be willing to use some of that money for withdrawals if that can be done without penalty.

Would you suppose the administrator of the 401k plan would be familiar with whatever needs to be done to withdraw money without penalty prior to 59 1/2? And no five year commitment on withdrawals? (I imagine yes, but is there a specific "magic term or phrase" that would make it clear to them what I wanted to do?).

Thanks muchly!

Rob
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Author: TMFBreakerRob Big gold star, 5000 posts Old School Fool Home Fool Supernova Phoenix 1
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Subject: Re: MLPs in IRAs Date: 8/10/2010 10:09 PM
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Typically, as the unit holder's holding period increases and less depreciation is passed through to the unit holder, less of the unit holder's cash flow will be shielded from taxation. At that point, the investor may want to consider selling the old MLP and reinvesting the proceeds in a new MLP that will be able to shield more of the cash flow from taxable income. Alternatively, if the investor wants to retain ownership in the original MLP, the investor might purchase additional units in order to receive a step-up in basis in the partner's proportionate share of depreciable property on the new units, with the result that a greater percentage of cash flow will be shielded from taxation. -- Ref: OSUMAG

Hmmm....

It would be interesting to try this on a small scale in part of the portfolio while retaining normal (static) positions in another part of the portfolio (at another IRA) and seeing whether this approach is an improvement. Definitely not something that I would normally do, because I never think about tax effects within my IRAs...and I usually make buy/sell decisions even in taxable accounts with the tax effects being secondary considerations.

Thanks for the thought....

Rob
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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110860 of 121585
Subject: Re: MLPs in IRAs Date: 8/10/2010 10:24 PM
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Would you suppose the administrator of the 401k plan would be familiar with whatever needs to be done to withdraw money without penalty prior to 59 1/2? And no five year commitment on withdrawals? (I imagine yes, but is there a specific "magic term or phrase" that would make it clear to them what I wanted to do?).

They should be, but it doesn't matter as long as you are. The important things are that you turn 55 in the year you leave the employer and you don't roll your 401(k) into an IRA, where you fall under the 59 1/2 rule.

You can read up on this in IRS Publication 575. While you're there, be sure to bone up on Net Unrealized Appreciation (NUA). You might be a good candidate for taking a distribution of company stock that you don't intend to sell quickly.

Phil
Rule Your Retirement Home Fool

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Author: OSUMAG Two stars, 250 posts Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110862 of 121585
Subject: Re: MLPs in IRAs Date: 8/10/2010 10:58 PM
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Rob,

Thanks for the link to the UBTI historical data.

http://www.investorvillage.com/smbd.asp?mb=5028&mn=8105&...

If you look at the 2007/2008 data from above, there is some correlation with the longer you hold the investment, the more taxable income or UBTI you tend to have reported on the K-1.

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Author: TheTortoise One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110863 of 121585
Subject: Re: MLPs in IRAs Date: 8/10/2010 11:15 PM
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What are the taxation differences between owning MLP ETFs (such as AMJ) and owning individual MLPs with regard to (1) amount of tax, and (2) complexity of tax filing?

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Author: OSUMAG Two stars, 250 posts Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 110864 of 121585
Subject: Re: MLPs in IRAs Date: 8/11/2010 12:17 AM
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What are the taxation differences between owning MLP ETFs (such as AMJ) and owning individual MLPs with regard to (1) amount of tax, and (2) complexity of tax filing?

TheTortoise,

AMJ is not an ETF; rather, it is an ETN or exchange-traded note, which is an unsecured debt of the issuer (in this case, JP Morgan Chase). The ETN pays a variable quarterly coupon based on the cash distributions paid by the MLPs in the index.

You will not receive any K-1s or have any filing obligations. Any distributions will be ordinary income and you will receive a 1099 at the end of the year. This ETN is an excellent candidate to be held in an IRA.

See FAQs on tax treatment: http://www.jpmorgan.com/cm/BlobServer/AMJ_FAQs_on_tax.pdf?bl...

See details on AMJ ETN: http://www.jpmorgan.com/pages/jpmorgan/investbk/solutions/sp...

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Author: TMFBreakerRob Big gold star, 5000 posts Old School Fool Home Fool Supernova Phoenix 1
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Subject: Re: MLPs in IRAs Date: 8/11/2010 6:25 PM
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You can read up on this in IRS Publication 575. While you're there, be sure to bone up on Net Unrealized Appreciation (NUA). You might be a good candidate for taking a distribution of company stock that you don't intend to sell quickly. -- Phil

Thanks, Phil!

And thanks to the rest of you as well. I appreciate your selfless efforts to help a wanderer who certainly can't offer any good advice back to you. :)

Rob
RB Home Fool

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Author: vinney11 Two stars, 250 posts Old School Fool CAPS All Star Global Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 111011 of 121585
Subject: Re: MLPs in IRAs Date: 9/9/2010 11:05 PM
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There is one other thing you might want to consider. The $1000 limit on UBTI before taxes are a problem appears to be by account. So you can split your MLP investments over a few IRAs to help avoid the taxman.

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 111013 of 121585
Subject: Re: MLPs in IRAs Date: 9/10/2010 12:19 AM
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The $1000 limit on UBTI before taxes are a problem appears to be by account.

That is not correct.

You may separate your Roth IRA from your traditional IRA. And you may separate your IRAs from your spouse's IRAs. But for all tax purposes, your various IRA accounts are treated as a single account.

Which raises another problem. If you DO have UBTI in different IRA accounts, it is quite possible that no one IRA custodian will know that you need to file a tax return for your IRA. It would be up to you to check the filing requirement and make sure that a return is filed.

--Peter

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Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 111014 of 121585
Subject: Re: MLPs in IRAs Date: 9/10/2010 6:12 AM
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You may separate your Roth IRA from your traditional IRA. And you may separate your IRAs from your spouse's IRAs. But for all tax purposes, your various IRA accounts are treated as a single account.

Which raises another problem. If you DO have UBTI in different IRA accounts, it is quite possible that no one IRA custodian will know that you need to file a tax return for your IRA. It would be up to you to check the filing requirement and make sure that a return is filed.


Peter, do you have a reference on that? I spent a lot of time researching what I have available (just Code, Regs, forms & instructions) and reached the same conclusion as OP. But I also recall feeling uneasy about it since it seemed to me the IRS itself wasn't exactly sure.

It's been a while, but IIRC I found nothing that got around the fact that each IRA account is a unique trust, thus a unique taxpayer. In the case of, for example, distributions when there have been after-tax contributions it's clear that you must look at all accounts as one. But I couldn't find anything similar with respect to UBIT.

Phil
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Author: Wradical Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 111015 of 121585
Subject: Re: MLPs in IRAs Date: 9/10/2010 10:38 AM
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(Peter:)Which raises another problem. If you DO have UBTI in different IRA accounts, it is quite possible that no one IRA custodian will know that you need to file a tax return for your IRA. It would be up to you to check the filing requirement and make sure that a return is filed.
(Phil:) I spent a lot of time researching what I have available (just Code, Regs, forms & instructions) and reached the same conclusion as OP. But I also recall feeling uneasy about it since it seemed to me the IRS itself wasn't exactly sure. It's been a while, but IIRC I found nothing that got around the fact that each IRA account is a unique trust, thus a unique taxpayer. In the case of, for example, distributions when there have been after-tax contributions it's clear that you must look at all accounts as one. But I couldn't find anything similar with respect to UBIT.

===========================================
I couldn't find anything that directly on point, either. But I did find a couple of references to the responsibility for filing of a 990-T being "the fiduciary" - which is generally the custodian. As noted, the fiduciary wouldn't know the exent or nature of other holdings
in other IRA accounts. So maybe it is an account-by-account deal. Or maybe you aggregate accounts held with the same trustee.
And having multiple MLPs in multiple IRA accounts could be either a good or bad thing. Yes, you might avoid aggregating income over $1,000. But you might also lose the ability to net gains and losses from different MLPs.

Bill

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Author: ptheland Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 111016 of 121585
Subject: Re: MLPs in IRAs Date: 9/10/2010 11:04 AM
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Peter, do you have a reference on that?

To be honest, no. I was just working from gut feel that this seemed like too easy a way around the general UBTI issues in an IRA.

--Peter

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