....Question: Should I hold MLPs in tax-advantaged IRA accounts?
It is not illegal to hold MLPs in an IRA account; however, some of the income you receive from the MLP is unrelated business taxable income (UBTI). UBTI income over $1,000 per year can be subject to tax even though it’s generated by a firm in a tax-free retirement account.
You do not have to pay taxes related to UBTI directly; this tax would be paid by the company acting as custodian on your IRA, and the custodian would also be forced to file the appropriate forms with the government. However, the custodian would pass along those costs to you.
Second, because MLPs are already tax-advantaged it makes sense to hold them when possible in a taxable account. After all, one of the main attractions of MLPs is the tax deferral of return of capital income; you don’t get this advantage inside an IRA account.
There are several MLPs and related investments you can hold in an IRA that do not generate UBTI: Navios Maritime Partners (NYSE: NMM), Kinder Morgan Management (NYSE: KMR) and Kayne Anderson Energy Fund (NYSE: KYE)....
You are right that the distribution is a return of capital; hence, it is tax deferred. This is a come-on bait of the MLP. Also, you are right that the UBTI is taxed if it excesses $1,000 per account.
But..... remember this if MLP stock(s)in your taxable account:
1. While you hold you MLPs stock(s), your partnership interest, items 1 thru 11 of your K-1 form, is taxable.
2. The real whammy is when you sell your MLP stock(s), you have to pay taxes on ordinary gain, partnership interest, and capital gain. If you hold your MLP stocks too long, you may need vasaline ointment for your rear end.