Negative UBIT in IRA

[taxxcpa]

I have a few share of Line Energy LLC (LINN) and have been in a discussion on another forum about whether the sale of this investment within the IRA could generate UBIT.

LINN has negative UBIT, but the person I've been discussing it with thinks that when you sell the investment, the recapture of depreciation changes the negative UBIT into positive UBIT and could create a UBIT tax if it exceeded $ 1000.

My view is that UBIT does not change to positive until some future date when it might change for all owners whether they sell or don't sell. Since the depreciation recapture will reduce the partners' capital every year, there could be a significant capital gain if you sold it in a non-IRA account--but if you sold it in an IRA the tax would not arise until you withdrew the money received for the sale.

Is there any basis for the contention that the recapture of depreciation would create UBIT?

[Roland Slugg]

Is there any basis for the contention that the recapture of depreciation would create UBIT?

None whatsoever.

IRAs don't pay taxes. Nor do they earn UBIT. UBIT applies only to non-profits, and an IRA is not a non-profit organization.

All funds that are withdrawn from an IRA are taxed as ordinary income to the recipient, unless some (or all) of the funds going into the IRA were non-deductible contributions. For that reason, IRA owners should think twice before investing their IRA funds in investments that generally yield capital gains. Taxpayers should look for ways to convert ordinary income into capital gains ... not the other way around.

[appelman]

Au contraire!

I am not sure of the answer to Roland's specific question, but IRA's can indeed be subject to UBIT rules. If you Google "UBIT IRA," you'll find a gaggle of references, among them:

http://irataxservices.com/?q=node/3

[taxxcpa]

Form 990-T states you must pay UBIT if over $1000

See also, under who must file, in the instructions for Form 990-T.

http://www.irs.gov/pub/irs-pdf/i990t.pdf

IRAs with over $1000 in UBIT must file.

My question is whether negative UBIT somehow coverts to positive UBIT when you sell your shares in a MLP--even though people who don't sell still have negative UBIT on their K-1s.

[Snaggletooth]

What Am I Missing

I have a few share of Line Energy LLC (LINN) and have been in a discussion on another forum about whether the sale of this investment within the IRA could generate UBIT.
Is there any basis for the contention that the recapture of depreciation would create UBIT?

How in creation can shares of stock have accumulated depreciation? Have I missed something?

[JohnH]

Ron:
It's an LLC operating as a partnership (I think)

[taxxcpa]

Ubit

My understanding is that UBIT is due to leveraging done by MLPs which means that a portion of their income relates to debt as a percentage of income and is considered UBIT. Since you are not allowed to borrow within an IRA any income related to borrowing is taxed as UBIT.

An MLP with no debt would have no UBIT to report on line 20V of the K-1.

But some people think recaptured depreciation creates UBIT at the investor level for a MLP with no UBIT. I would llke to know if this is correct.

I would especially like to know where, in the tax laws it says recaptured depreciation does nothing more than create a taxable gain in a non-IRA account while creating UBIT in an IRA.

[Roland Slugg]

Oops ...

This thread should serve as a reminder not to post a reply, without doing a little reading or research first, to someone's question regarding a highly unusual subject about which I have no recent experience. As others pointed out, and as I just learned by doing a little reading, IRAs (but not 401(k)s) can indeed owe UBIT in a few situations.

What I think I would do if this were my client is tell the IRA owner that his IRA may, indeed, have taxable UBIT and even if it does not, because there is a $1,000 exemption, the IRA Trustee may still have to file form 990-T if the IRA's share of gross income from the "unrelated trade or business" is over $1,000. This information should be disclosed on the K-1 the IRA will receive from the LLC (LINN) each year.

[JohnH]

That's one of the great things about this forum.
We can make mistakes here rather than with a client sitting in front of us.

I can think of a few times that a gentle correction I received here (and maybe one or two not-so-gentle corrections), directly resulted in money in the bank which might not have otherwise been there.

[oceanlovin'ea]

HATE this subject

I hate this subject. My husband nearly went nuts a couple of years ago (or maybe it was last year). He had invested some of the IRA money in a couple of these MLPs. He read and read and read and read and then read to me over and over. We never did figure anything out.
I'm not sure if he still has them or not. But what I decided was that if after all that reading and discussion we couldn't figure it out, probably IRS can't figure it out either. But we don't buy any more of them.

Linda, EA

[taxxcpa]

Ubti

Although no one has answered my specific question, I think Roland Slugg's second comment, by implication, would indicate that the IRA custodian would have to make the filing if (and only if) Line 20V of the K-1 indicated UBTI. In other words, the only UBTI would be what Line 20V of all K-1s added up to.

If that is the case, then recapture of depreciation would only trigger UBTI if it caused Line 20V to show UBTI of over $1000 and selling your shares in the LLC would not create some kind of UBTI that applied only to people selling their shares.

I think my phrasing of the original question should have been more explicit in asking if any UBTI other than amounts on Line 20V of K-1s to non-selling investors could be triggered on someone selling their interest in the LLC.

[jimfrombx]

UBTI _on sale of stock

As oceanloving-ea said this is a very complicated issue, MLP's in an IRA. About a year ago in Seeking Alpha, one of their contributors claimed that an IRS reg (don't have it) says that when you sell an MLP in an IRA that you may have UBIT that has to be recaptured and reported. The problem is that only the MLP knows your figures and that is reported on your Final K1. While you may have owned the MLP in years the UBIT was negative, some of that may have been because of depreciation, depletion or intangible drilling costs reduced your income and came up with the negative UBIT.
Investorvillage.com had a lively discussion but I don't recall anyone ever "winning the argument" I now see individuals saying you should file 990-T every year that you have negative
UBTI so when you have positive UBTI you can offset them. I have looked at 990-T a fewtimes and can't figure out how that works.
A number of individuals have claimed to have been buying and selling MLP's in their IRA for years and never had an IRS problem. While that was probably true, and calls to the IRS now may
give you the impression they don't have a clue either.
However, the K1's seem to be popping up on the IRS CP_____ more often and eventually they may get some intelligent reviews by the IRS. The advice of MLP's in IRA's has generally been don't put MLP's with positive UBIT in an IRA. It now seems that selling an MLP in an IRA may also generate UBTI.

[taxxcpa]

UBTI on MLP in IRA

I've been pursuing this on Seeking Alpha, this forum and other forums. One of the contentions cited in support of the concept that selling an MLP would create UBTI over-and-above the UBTI reported on line 20V is that sale of section 1245 assets is subject to recapture of depreciation--and they interpret recapture of depreciation as synonymous with UBTI. While it is true that sale of Sec 1245 assets could result in UBTI, I believe this means that when the MLP itself sells such assets it would create UBTI to be reported on Line 20V of the K-1.

I do not believe that selling your investment in an MLP constitutes the sale of a 1245 asset. Even if you contend that some percentage of your investment represents Sec 1245 assets, it would be virtually impossible to ascertain what percent.

My conclusion is that only if the MLP provides selling ex-owners with a breakdown of the gain related to the sale of Sec. 1245 assets could any UBTI be generated other than the figures reported on Line 20V regardless of whether you still owned an interest on Dec 31 or if you sold them in November.

I would like to hear any arguments proving I'm wrong. I have tried to find something that would convince me that I'm wrong.
I have made a sale of an MLP in 2012 so I may get a clue when I get my final K-1. I may sell some more MLPs in my IRA in 2012 and would get more clues. My investments in these MLPs held in my IRA are small, so I don't think that the UBTI would be $1000, but I'm curious as to the way they report it.

One other point. I raised the question of whether you could offset negative UBTI on LINN with positive UBTI on VNR. Someone who was a retired Trust Fund manager said they could not be offset. If that is the case, it would seem that if you have $900 in positive UBTI in several MLPs, you could escape the tax.

And, finally, I doubt that the IRS would ever suspect that you owed tax on UBTI unless one of your K-1s had more than $1000 on it--regardless of whether the sale of an MLP in an IRA, in itself, creates UBTI.

[JohnH]

I'm still puzzled by why any financial advisor would suggest holding MLP interests in an IRA. It just makes no sense to me from an investment standpoint. Add the UBTI complication and it seems to me the only motivation for such a recommendation would be commissions.

[taxxcpa]

MLP in IRA

Actually it is better to have an MLP in an IRA than in a taxable account if you receive less than $1000 in UBTI.
Most of the MLPs I've invested in have negative UBTI. Vanguard Natural Resources has positive UBTI but only a small part of the yield is considered as ordinary income or UBTI.

You should not invest $100,000 in an MLP within an IRA because an investment of that size might generate over $ 1000 in UBTI. But if you are only investing $5000 in any one MLP, there is unlikely to be $1000 in UBTI unless the yield is 20%.

Even if the yield was 20%, very little of the yield is taxable income due to DD&A which reduces taxable income but does not reduce cash available to distribute.

The advantage is that the yield might be over 10% and in an IRA you don't have to enter the K-1 information on your tax return. If someone invests a small amount in a non-IRA account, it will probably cost them more in tax preparation fees than their income from the MLP.