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The Best Place to Hold REITs and MLPs: An IRA or a Taxable Account?

Q: What is the best account to hold REITs and master limited partnerships? Is there a prohibition against holding these shares in a rollover IRA? Is there a penalty or tax when these equities are sold?

Richard Swan,

Okeechobee, Fla.

A: Real-estate investment trusts and master limited partnerships—or REITs and MLPs—are suddenly popular, largely because their often-hefty yields are treasured in a low-interest-rate world. REITs sport yields of nearly 4% lately, while MLPs have yields of more than 6%. They also are perceived as being safer than some other investments.

A REIT owns and manages buildings, mortgages or other types of real estate and trades like a stock. REITs don't pay corporate taxes as long as they distribute at least 90% of their taxable income to holders.

MLPs are publicly traded partnerships that generally own and operate oil and gas pipelines. They pay no federal taxes. Instead, all earnings go directly to their partners, known as unit holders, who pay taxes. Units trade on exchanges.

Keep in mind that when global interest rates eventually rise, REITs and MLPs likely will come under pressure as investors shift to government and corporate bonds, analysts note.

Before considering what type of investment account should hold a REIT or MLP, consider what kind of REIT or MLP it is, says Mark Martiak, senior vice president at Premier Wealth Advisors/First Allied in New York. Mr. Martiak notes that some REITs are traded on major stock exchanges while others are "nontraded" REITs. Traded REITs are easier for investors to buy and sell, while nontraded REITs are harder to trade and are only priced periodically by the sponsor.

Brokers sometimes mislead investors about the potential benefits and risks of nontraded REITs, regulators have warned, and they've been attacked by critics for their high fees and conflicts of interest.

Advisers say there's no prohibition against holding MLPs or traded REITs in a rollover individual retirement account or other tax-advantaged account, nor is there a penalty or tax on proceeds when these equities are sold. Ownership of nontraded REITS may result in penalties for certain IRA distributions, and there may be complications with keeping an MLP in an IRA.

There are good reasons to place a traded REIT in an IRA. Matthew Senicola of JHS Capital Advisors, who is based in Plainview, N.Y., recommends placing traded REITs in an IRA because taxes on the dividends can be fully deferred. In a taxable account, by contrast, a large portion of the sizable dividends of REITs is treated as ordinary income, which generally subjects it to higher tax levels.

Many advisers recommend placing MLPs in taxable accounts because some MLPs can generate more than $1,000 of annual unrelated business-tax income, or UBTI. Anything beyond that level could incur taxes.

Mark Nash, a Dallas-based personal financial services partner in PwC LLP's Private Company Service, says the risk of passing this $1,000 threshold is why most investors should place MLPs in taxable accounts, even though income in an IRA generally isn't taxed until it is withdrawn.

He adds that MLPs are ideal for taxable accounts "because often the MLPs' distributions are tax-advantaged" since MLPs frequently avail themselves of certain business deductions, such as depletion.

David Lehn, a partner at New York law firm Withers Bergman LLP, says some "MLP die-hards" continue to place MLPs in IRAs because they believe there won't be very much UBTI tax for the IRA to pay. But he notes that some banking institutions don't like holding MLPs in IRA accounts.

Still, the Internal Revenue Service has changed its ruling on this issue at least once and some REITs do risk generating UBTI, Mr. Nash cautions.

Mr. Zuckerman is a reporter for The Wall Street Journal in New York. He can be reached at Follow him on Twitter at @GZuckerman .

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