The Self-Directed IRA is an extraordinarily flexible and powerful vehicle for building long-term wealth for retirement. The ability to invest in companies beyond publicly-traded C-corporations – taxed at nearly 40 percent before the shareholder ever gets to see a dime – is among the most attractive features of the Self-Directed IRA account. Self-Directed IRA owners can’t own S-corporations in their IRAs, but they can own LLCs and partnerships, including master limited partnerships, which are limited partnerships that are traded on stock exchanges.
As such, master limited partnerships – MLPs – have some significant advantages for certain taxpayers both in and out of retirement accounts, and have the additional advantage of the extra degree of liquidity that comes with owning a publicly-traded security, as opposed to a share of a very closely held company with a very limited and difficult to access market.
Declining oil prices have been tough on MLPs over the past couple of years. This is because oil and gas businesses routinely choose the limited partnership structure. But many of them still deliver significant cash flow yield.
But the tax advantages of MLPs are attenuated when you use them in retirement accounts such as Self-Directed IRAs. Many MLPs themselves are leveraged, which may generate unrelated business taxable income liability (UBIT). This is a tax that Congress levies against growth or income that is attributable to capital borrowed from outside the tax-advantaged retirement account.
This can occur when you use margin to buy stocks or securities within a Self-Directed IRA, when you use a nonrecourse loan to buy real estate within a Self-Directed IRA (though 401(k)s are exempt from this tax, under certain circumstances), and investing in an active business or trade within a pass-through entity, including a partnership.
Don’t Get Blindsided
MLPs can be very lucrative opportunities for the skilled investor. And they can provide excellent diversification benefit depending on market conditions, since these investments often do not track with large stock indexes such as the S&P 500. But the tax on unrelated business income from partnerships is a significant 39.6 percent on anything above $12,300 per year (unless you are receiving less than $1,000 in income).
If you own units in limited partnerships or master limited partnerships within a Self-Directed IRA, expect to receive an IRS Form 990-T from your IRA custodian or third party administrator early in the year. Your retirement account must pay this tax by April 15th. You generally cannot use funds from outside the retirement account to pay the tax on limited partnership or MLP income.
This is something that is routinely spelled out in prospectus documents for limited partnerships, but many investors still get taken by surprise. So keep some liquidity in your retirement account to pay potential taxes.
If you choose to hold MLPs within your retirement accounts, then, buy them for the yield and for the diversification benefit, and because they are simply good values relative to their intrinsic value – like a good value investor. Don’t ‘let the tax tail wag the investment dog,’ as they say.
Occasionally investors get stung by a custodian or third-party administrator with insufficient experience with alternative asset classes such as limited partnerships and MLPs who fail to prepare an IRS Form 990-T form. This can get the investor in hot water with the IRS.
This is why it’s important to handle Self-Directed IRAs and other retirement accounts with an experienced third-party administrator who specializes in self-directed retirement accounts. American IRA, LLC founder Jim Hitt has been investing in self-directed retirement accounts for over 30 years. With offices in Asheville and Charlotte, North Carolina, American IRA, LLC works exclusively with Self-Directed IRAs from coast to coast, providing reliable record keeping, transactional support and compliance with IRS rules for thousands of Self-Directed IRA owners and 401(k) plan sponsors, while saving thousands in fees, in many cases.
For more information, or to schedule a no-obligation consultation, visit www.americanira.com, or call us at 866-7500-IRA (472).
We look forward to working with you.