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I've been learning a lot about master limited partnerships (MLPs) lately. I have an IRA that has some units of an MLP. Thankfully this specific MLP doesn't produce year-to-year unrelated business taxable income (UBTI) as UBTI is taxed, even in an IRA for amounts that exceed $1000 per year.

That is nice but, my MLP units do pay quarterly distributions that "adjust" my taxable cost-basis downwards relative to my "original" cost-basis. The difference between my "adjusted basis" and my "original basis" is something called "recapture" and, upon the sale of the MLP units, this "recapture" is subject to taxation, even in an IRA. However, it is my understanding that "recapture" is classified as UBTI. Thus, if one sells MLP units in an IRA, and the "recapture" is less than $1000, then there are no taxes due.

Supposing that the above logic holds, could one use the following strategy to manage their IRA's tax liability: Sell units of the MLP that have a recapture liability of less than $1000. Then hastily re-purchase the same number of units, thereby resetting the "recapture" at $0.
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I've been learning a lot about master limited partnerships (MLPs) lately. I have an IRA that has some units of an MLP. Thankfully this specific MLP doesn't produce year-to-year unrelated business taxable income (UBTI) as UBTI is taxed, even in an IRA for amounts that exceed $1000 per year.

OK, so far so good.

That is nice but, my MLP units do pay quarterly distributions that "adjust" my taxable cost-basis downwards relative to my "original" cost-basis.

Yes, but I hope you're aware that's only half the story. Your basis is also adjusted by your share of the partnership's income/gains/losses, etc. (increased for income, decreased for losses.)

The difference between my "adjusted basis" and my "original basis" is something called "recapture" and, upon the sale of the MLP units, this "recapture" is subject to taxation, even in an IRA. However, it is my understanding that "recapture" is classified as UBTI.

Not exactly. First of all, the partnership itself may have recaptured gains. "Recapture" is a reclassification of gains from capital gain to ordinary income, usually attributable to depreciation and depletion deductions (which are thus "recaptured.") This would be reflected in your regular K-1 entries. And, to the extent that your ordinary income is also UBTI, then yes, the recapture item would also be UBTI.

Secondly, on the sale of the units themselves, there is the potential for some or all of the sale to be treated as ordinary income because your share of the partnership's potential gain from the sale of "hot assets" (ordinary income items) is imputed to you on the sale. And you don't REALLY know what that is, until you get your final K-1 for the year of sale.

But beyond that, a gain on the sale of the shares themselves should not be UBTI.

I think an easier approach is to keep LP shares in your personal/taxable account, and keep the IRA for stocks, bonds, and even REITS should be OK.

Bill
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Thanks for the reply Wradical. Some follow-up questions and thoughts:


Yes, but I hope you're aware that's only half the story. Your basis is also adjusted by your share of the partnership's income/gains/losses, etc. (increased for income, decreased for losses.)


I am aware...just using expositional expedience! ;)


But beyond that, a gain on the sale of the shares themselves should not be UBTI.


That's what I understand too: the difference between my sale price and my "original" basis is considered capital gains. And the IRA is exempt from capital gains taxes.

But, upon the sale of units, the difference between my "original" basis and the "adjusted" basis (which, of course, subtracts distributions but adds back in the "taxable income" part of the distributions) is taxable income to the IRA. And this taxable income is classified as UBTI.

As I've held my units for some time this difference between my "original" and "adjusted" basis is steadily creeping close to $1K. I want to retain my interest in this MLP. But, I also want to manage the taxes effectively. So, I figured that if I sold my units into the market, then quickly re-bought units out of the market, that I could reset the recapture to $0, while still staying under the $1K UBTI limit.

If that strategy is permissible it would even work for taxable accounts. And it's quite tax efficient because the marginal rates on UBTI are progressive. So, it would surprise me if the IRS lets you do it! ;)


I think an easier approach is to keep LP shares in your personal/taxable account, and keep the IRA for stocks, bonds, and even REITS should be OK.


Perhaps. And I see this advice in many places. But, I think that's just because holding MLP units requires some non-standard book-keeping and takes a little time to wrap one's head around the strategy space. That said, holding the units in a taxable account is not a panacea...you still have to keep track of your adjusted basis and keep an eye on UBTI (and pay taxes if it gets over $1K), especially if you've held your units for a while and your adjusted basis gets down to $0.
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That said, holding the units in a taxable account is not a panacea...you still have to keep track of your adjusted basis and keep an eye on UBTI

You've gotten confused somewhere along the line. UBTI is a concern only for tax-exempt entities, e.g., IRAs. When you hold an MLP in a taxable account and your basis reaches zero because of returns of capital you start paying tax on future distributions. Likewise if there's ordinary income to report.

Phil
Rule Your Retirement Home Fool
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When you hold an MLP in a taxable account and your basis reaches zero because of returns of capital you start paying tax on future distributions. Likewise if there's ordinary income to report.


Thanks. Got it. I'm still learning about all the ins and outs of MLPs...and my focus has been strictly when they're held in an IRA.
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