Can an IRA be taxed?
Most sites that I have looked at make very broad statements about all IRA gains being shielded from taxation. For example, RothIRA.com makes the following statement about traditional and Roth IRAs:
with both types of IRAs, you pay no taxes whatsoever on all of the
growth of your contributed funds, as long as they remain in the
account
However, this article on The Motley Fool website makes a distinction between trading stocks for C corporations versus others (S corporations and LLCs specifically) within an IRA. It claims that trading S corporation and LLC stocks often results in UBTI and that:
when you hold shares of this type in a tax-advantaged account like
an IRA, it could mean your IRA is subject to paying UBTI. Under
current IRS rules, if your IRA earns more than ,000 in total UBTI in
a tax year, you must pay income tax on those earnings. Most people
therefore tend to avoid holding these sorts of investments inside an
IRA. And while it shouldn't necessarily rule out every potential
investment of this type, the cost in taxes may keep these investments
from being the best choice for your IRA.
Unless I am reading this incorrectly, it seems to claim that there can be income tax resulting from IRA investments.
In addition, the opening section of the article qualifies each statement about taxes with the phrase "in most cases," as if they are being very careful to not give a blanket statement.
So, The Motley Fool article claims that "most people" are avoiding certain IRA investments because they're taxable, but the RothIRA.com article claims that there are "no taxes whatsoever". What am I missing?
Is it true that only C corporation stocks are shielded from taxation within an IRA? Could someone owe income tax from their IRA investments?
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The Motley Fool article is correct that if you earn UBTI over 00, you will need to pay the tax, even if held in an IRA.
C-corps won't generate UBTI, so you're fine with those. For non-C-corps, the most common are REITs, MLPs, and BDCs.
REITs
These typically invest in either real estate property or mortgages. The ones that invest in mortgages are sometimes notated: mREITs, and can occasionally generate UBTI. Tip: Don't let this stop you from investing in REITs in your IRA. REITs can be a great source of income and are best held in an IRA since the income will be tax free vs. your ordinary income tax bracket if held in a taxable account. Some examples of mREITs would be NLY, CIM, AGNC. Some property REITs would be: O, SNR, OHI, EQR.
seekingalpha.com/article/1257351-tax-bomb-mortgage-reits-triggering-ubit
MLPs
Master Limited Partnerships are also pass-through entities, like REITs, but have the additional complication that most issue K-1 forms at tax time. K-1s can be very complex when the MLP owns assets across state boundaries, which is why I actually PREFER to hold MLPs in my IRA (against the advice of M. Fool) since I won't have to deal with the tax complications of filing the K-1, just as long as my MLPs don't generate over 00 of UBTI.
seekingalpha.com/article/4057891-mlps-kminus-1s-ubti-oh
BDCs
Business Development Companies like REITs and MLPs are also pass-through entities in that the income they give you will be taxed at your ordinary income bracket if held in a taxable account. Examples of BDCs include: MAIN, MCC, ARCC. You'd need to consult their 10-K to determine if there is a risk of UBTI.
Tip: MLPs, BDCs, and especially REITs can all be very valuable sources of income and from my experience, UBTI is rare so don't let that scare you away if you otherwise like the investment.
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