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MLPs are funds that own energy infrastructure like pipelines, refineries and storage tanks. To avoid tax at the company level, they pass most of their income onto shareholders, so they appeal to income-oriented investors. UBTI is income from something not directly related to the MLP’s main business – like a lunch stand at a refinery.
“Each taxpayer is allowed a $1,000 limit on UBTI in their IRAs. But above that, you’re looking at a taxable event,” Birken says.
Investors are wise to find out whether the MLP typically disburses UBTI. Issuance of a Form K-1 is a tip-off.
Real estate investment trusts. REITs are funds that own real estate like apartments and office buildings, and they pass most income onto shareholders. Like MLPs, they are sought for their high yields. But investors need to be aware that not all REIT dividends are the same, says, Scott K. Laue, financial advisor at Savant Capital Management, a wealth management firm in Rockford, Illinois.
Some REIT income is qualified dividends, which are taxed at 15 percent for most investors, while others are ordinary dividends taxed at higher income tax rates, Laue says.
“This sometimes creates unwelcome surprises come April 15th,” he says.