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Most sites that I have looked at make very broad statements about all IRA gains being shielded from taxation. For example, RothIRA.com makes the following statement about traditional and Roth IRAs:

with both types of IRAs, you pay no taxes whatsoever on all of the growth of your contributed funds, as long as they remain in the account

However, this article on The Motley Fool website makes a distinction between trading stocks for C corporations versus others (S corporations and LLCs specifically) within an IRA. It claims that trading S corporation and LLC stocks often results in UBTI and that:

when you hold shares of this type in a tax-advantaged account like an IRA, it could mean your IRA is subject to paying UBTI. Under current IRS rules, if your IRA earns more than $1,000 in total UBTI in a tax year, you must pay income tax on those earnings. Most people therefore tend to avoid holding these sorts of investments inside an IRA. And while it shouldn't necessarily rule out every potential investment of this type, the cost in taxes may keep these investments from being the best choice for your IRA.

Unless I am reading this incorrectly, it seems to claim that there can be income tax resulting from IRA investments.

In addition, the opening section of the article qualifies each statement about taxes with the phrase "in most cases," as if they are being very careful to not give a blanket statement.

So, The Motley Fool article claims that "most people" are avoiding certain IRA investments because they're taxable, but the RothIRA.com article claims that there are "no taxes whatsoever". What am I missing?

Is it true that only C corporation stocks are shielded from taxation within an IRA? Could someone owe income tax from their IRA investments?

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    I would presume that the Fool article is describing "fringe" investments that are very unlikely to be wrapped in an IRA, while the RothIRA article is making a broad statement about the vast majority of investments (stocks, mutual funds) being shielded from tax. Do you have a specific investment that you are concerned about or are you just verifying the contradiction? – D Stanley Jul 10 '17 at 21:46
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    @DStanley No specific investment, I have just always heard that IRA growth is completely tax-free, and the Fool article is the first time I've even seen a distinction made (and they are very direct about it). They also seem to imply (the use of the word "therefore") that most people actively choose to avoid such IRA investments since they are taxable, as opposed to simply avoiding them because they are uncommon. I guess my concern would be that I might accidentally purchase shares of an S corp or LLC (or a fund containing one) and have a tax liability I was unaware of? – elmer007 Jul 10 '17 at 21:54
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    S-corps and LLCs cannot be publicly traded, so I doubt you'll "accidentally" invest in one through your IRA. – D Stanley Jul 10 '17 at 22:22
  • @DStanley Thanks, that's good to know, especially given my IRA activity so far hasn't been anything unusual. Any reason why you deleted your answer? I got a notification for it, but I didn't get to read it :/ – elmer007 Jul 11 '17 at 16:26
  • too many assumptions/guesses as I am not an expert in that area. – D Stanley Jul 11 '17 at 16:40
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The Motley Fool article is correct that if you earn UBTI over $1000, you will need to pay the tax, even if held in an IRA.

C-corps won't generate UBTI, so you're fine with those. For non-C-corps, the most common are REITs, MLPs, and BDCs.

REITs

These typically invest in either real estate property or mortgages. The ones that invest in mortgages are sometimes notated: mREITs, and can occasionally generate UBTI. Tip: Don't let this stop you from investing in REITs in your IRA. REITs can be a great source of income and are best held in an IRA since the income will be tax free vs. your ordinary income tax bracket if held in a taxable account. Some examples of mREITs would be NLY, CIM, AGNC. Some property REITs would be: O, SNR, OHI, EQR.

https://seekingalpha.com/article/1257351-tax-bomb-mortgage-reits-triggering-ubit

MLPs

Master Limited Partnerships are also pass-through entities, like REITs, but have the additional complication that most issue K-1 forms at tax time. K-1s can be very complex when the MLP owns assets across state boundaries, which is why I actually PREFER to hold MLPs in my IRA (against the advice of M. Fool) since I won't have to deal with the tax complications of filing the K-1, just as long as my MLPs don't generate over $1000 of UBTI.

https://seekingalpha.com/article/4057891-mlps-kminus-1s-ubti-oh

BDCs

Business Development Companies like REITs and MLPs are also pass-through entities in that the income they give you will be taxed at your ordinary income bracket if held in a taxable account. Examples of BDCs include: MAIN, MCC, ARCC. You'd need to consult their 10-K to determine if there is a risk of UBTI.

Tip: MLPs, BDCs, and especially REITs can all be very valuable sources of income and from my experience, UBTI is rare so don't let that scare you away if you otherwise like the investment.

  • I'm not sure I understand what you mean in the REIT part. It's in your list of investments that could generate taxable income for an IRA, but then you say "REITs can be a great source of income and are best held in an IRA since the income will be tax free". – elmer007 Jul 14 '17 at 21:34
  • Since REIT dividends are not qualified (since REITs are pass-through entities), if you hold REITs in a taxable account then you will pay taxes according to your ordinary income tax bracket level. For example, if you're in the 28% bracket and you make $1000/year in dividends, then you'll pay $280 in taxes. If you hold the REIT in an IRA, then you pay $0 in taxes. Caveat is UBIT, but again those are pretty rare and only apply to mREITs. – public wireless Jul 17 '17 at 14:38
  • Another thing that maybe wasn't clear is that even if you've chosen an mREIT, like NLY for example, and even if NLY has some UBTI for the year (not a given), then still only PART of the income you receive from NLY will count as UBIT, and it will depend on whatever their internal accounting was which will vary by company and by year. So if NLY pays a dividend of 10%, and you've invested $5000, then you'd get $500 in NLY dividends, but maybe only 20% would count as UBIT, so you'd still have a $900 cushion before hitting the $1000 UBIT threshold – public wireless Jul 17 '17 at 14:49

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