We’ve all heard the pitch: "Tax-advantaged structures all around!" But throw an MLP into a Roth IRA, and suddenly you’re on the hook for unrelated business taxable income. That changes everything. Most investors don’t see it coming until the tax bill arrives.
Understanding MLPs and Their Tax Quirks
Master Limited Partnerships are hybrids—publicly traded like stocks, but taxed like partnerships. That means no corporate income tax at the entity level. Instead, profits and losses flow through to investors. You get a K-1 form, not a 1099. And that single document changes the game.
Each partner is responsible for their share of the partnership’s income, even if none of it is distributed. Yes, you can owe taxes on money you never actually received. That catches people off guard every single year. I’ve seen it happen with otherwise sharp investors who assumed MLPs behaved like REITs or dividend stocks.
Now, here’s where it gets messy: depreciation deductions from the MLP often exceed actual income. That creates “phantom” losses on your tax return. Great in theory—they offset other income. But those losses also reduce your cost basis. When you sell, your capital gains could be sky-high, even if the stock price didn’t move much. It’s a bit like driving a car with invisible mileage.
How MLP Distributions Work Differently Than Dividends
MLP payouts aren't dividends. They’re distributions, and they’re mostly a return of capital. Only a small fraction might be ordinary income. The rest chips away at your cost basis. That defers taxes now but creates a bigger tax event later. Simple enough in a taxable account. Catastrophic when trapped in a retirement account.
And that’s exactly where the IRA problem begins.
The K-1 Complexity No One Talks About
You don’t get your K-1s in January. More like March. Sometimes April. If you hold MLPs across five different funds, good luck filing your taxes on time. One client of mine waited until June once—state penalties piled up. The IRS doesn’t care that the partnership was slow. You’re on the hook.
(And yes, states matter. Texas? No income tax. New York? They’ll want their cut. Multi-state filings become a real headache.)
Why Holding MLPs in an IRA Triggers UBTI Landmines
IRAs aren’t supposed to generate business income. That’s what unrelated business taxable income (UBTI) rules are for. Normally, retirement accounts dodge this. But MLPs? They’re the exception. Their structure produces UBTI by design.
Now, the IRS allows up to $1,000 of UBTI per year per IRA without penalty. Sounds generous. But hit $1,001? The entire IRA owes tax on Form 990-T. And the IRA itself pays it—not you personally. Which means draining assets from the account. You’re losing compounding growth to cover a tax bill you didn’t anticipate.
But wait—it gets worse. If you hold multiple MLPs, or large positions, UBTI stacks fast. One midstream energy MLP like Enterprise Products Partners (EPD) can push you over that threshold in a single holding. Two? You’re buried.
And that’s not speculation. In 2022, a large MLP investor with $150,000 in EPD units inside a traditional IRA triggered over $4,200 in UBTI. The IRA custodian filed the 990-T, paid the tax from account assets, and the investor didn’t even notice until their balance grew slower than expected. By then, years of silent erosion had happened.
UBTI Thresholds and Real-World Impact
The $1,000 exemption applies per IRA, not per investor. So you can’t dodge it by splitting holdings across Roth and traditional accounts. Each account is judged separately. A Roth IRA paying UBTI tax is especially painful—you’re burning tax-free growth to cover a tax bill. That’s the opposite of the point.
Experts disagree on whether small MLP positions are “safe.” Some say under $50,000 is manageable. But distribution yields vary. EPD yields about 6.9%. If 80% is return of capital, that’s still $3,000 in UBTI on a $50k holding. Over the limit. We’re far from it being risk-free.
Administrative Burden for Custodians
Not all custodians even allow MLPs in IRAs. Fidelity? Blocks them outright. Charles Schwab? Permits but warns. Smaller brokerages often won’t touch them. Why? The reporting burden. They have to file 990-Ts, withhold state taxes, and manage K-1 chaos. Most would rather avoid the hassle.
Which explains why custodial fees sometimes spike when MLPs are involved. One investor at Interactive Brokers reported a $75 annual fee just for holding one MLP in a rollover IRA. Not per holding—per account. That’s a quiet cost most don’t budget for.
Taxable Brokerage: The Only Sane Choice for MLPs
Run the numbers. Compare long-term net returns. After-tax, after-UBTI, after filing delays. You’ll find that taxable accounts outperform IRAs for MLPs, hands down. Even with higher current taxes on distributions, the structural advantages win.
You control the tax timing. You harvest losses when needed. You adjust basis accurately. And you avoid custodial fees, UBTI traps, and phantom IRA taxation. Yes, you’ll deal with K-1s. But that’s a paperwork cost, not a wealth destruction event.
Take someone investing $100,000 in MPLX (Marathon Petroleum’s MLP) yielding 8.1%. In a taxable account, 75% of that distribution is return of capital. Over five years, basis drops from $100k to roughly $70k. Sell at cost? $30k in long-term gains. Taxed at 15% federal, 5% state? $6,000 total. Net proceeds: $94,000.
Same position in an IRA? Assume $2,500 UBTI yearly. After five years, $7,500 in taxes paid from the account at ordinary rates—say 22%. That’s $1,650 in lost growth. Plus potential fees. Net? Likely under $92,000. The taxable account wins. Without factoring in flexibility.
State Tax Considerations You Can’t Ignore
Some states—Louisiana, New York, Texas—require separate partnership filings. You might owe taxes where the pipeline runs, not where you live. That’s not a typo. If your MLP owns infrastructure in Louisiana and you’re a New York resident, both states could claim a piece.
Data is still lacking on enforcement frequency. But audits are rising. The Louisiana Department of Revenue flagged over 12,000 out-of-state investors in 2021 for underreported partnership income. Penalties averaged $1,240. And that was before inflation pushed rates higher.
MLPs in Taxable vs. IRA: A Direct Comparison
Let’s compare outcomes—not theory, but net dollars.
Taxable Account: Annual K-1 delays. Basis tracking is manual (or requires premium software). Current taxes on small ordinary income portions. But no UBTI. No 990-T. Full control. Long-term capital gains at favorable rates. Ability to offset with other losses.
Traditional IRA: No current taxes. But UBTI risk. 990-T filings. Tax paid from account assets. Custodial restrictions. Basis tracking ignored. When you withdraw, distributions are taxed as ordinary income—even though the gains were largely deferred capital appreciation. That’s a terrible mismatch.
Roth IRA: Worse. Tax-free growth, except when UBTI forces taxable events inside a tax-free account. You pay taxes with tax-free dollars. That’s like burning dollar bills to heat your house in winter.
Because of this, I find the "MLPs in Roth" advice wildly overrated. The marketing pitch sounds smart—“tax-free MLP income!”—but it ignores reality. The structure fights itself.
Hybrid Approach: Capping MLP Exposure in Retirement Accounts
Some advisors suggest a middle ground: hold a tiny MLP position under the $1,000 UBTI threshold. Technically possible. But distributions change yearly. Commodity prices shift. One dividend hike and you’re over. Monitoring becomes constant. Is it worth it?
In short: probably not. The administrative overhead isn’t worth a $400 tax savings. You’re trading simplicity for fragility.
Frequently Asked Questions
Can I Hold MLP ETFs in an IRA?
Yes—and it’s often safer. ETFs like AMLP (Alerian MLP ETF) are structured as C-corps. They pay dividends, not K-1s. They handle the UBTI internally. So you get MLP exposure without the tax nightmare. But there’s a cost: double taxation at the corporate level. AMLP’s yield is around 7.3%, but effective tax drag cuts net returns by roughly 1.2% annually compared to direct holdings. A trade-off, not a fix.
What Happens If My IRA Exceeds the UBTI Limit?
The IRA files Form 990-T and pays the tax. You don’t get a deduction. The money comes out of your balance. No warning. No opt-out. And custodians don’t always notify you. It’s silent leakage. One investor lost 3.4% of his IRA value over three years without realizing why. The custodian had paid $2,800 in UBTI taxes. It’s avoidable. But only if you know.
Are There Any MLPs That Don’t Generate UBTI?
Honestly, it is unclear. Most do. But some newer structures—like those using a "blocker corporation"—can shield retirement accounts. These are rare, often private, and come with high fees. Publicly traded MLPs? Assume they generate UBTI. Don’t gamble.
The Bottom Line
Hold MLPs in a taxable brokerage account. Full stop. The complexity is manageable. The tax benefits real. The alternatives? Minefields. Advisors who suggest otherwise are either misinformed or selling something.
Yes, K-1s are annoying. Yes, basis tracking takes effort. But compared to silent UBTI erosion inside an IRA? It’s a feature, not a bug. You’re trading paperwork for control. And that’s a deal worth taking.
And if you’re dead set on MLP exposure in retirement accounts, use an ETF. Accept the tax drag. At least you’ll sleep at night. Just don’t pretend it’s optimal. Because it’s not.
Let’s be clear about this: the best account for MLPs isn’t about convenience. It’s about avoiding structural tax warps. The brokerage account wins—not because it’s perfect, but because the alternatives are worse. Sometimes, the right choice is just the least broken one.