I read somewhere that "Distributions from royalty trusts are taxed as capital gain instead of as individual income." At first I didn't care because whatever's in a Roth IRA grows tax free, right?
Wrong. From www.aaii.com/journal/article/dos-and-donts-of-ira-investing.touch (2010, so things may have changed?)
Master Limited Partnerships
Investors are most likely to be trapped by UBTI when an interest in a pass-through business entity (partnership, S corporation, or limited liability company) is held in an IRA. The IRA's share of a pass-through entity's income is considered UBTI regardless of the account holder's ownership percentage of the entity. Pass-through entities [emphasis is my own] generally do not pay federal income taxes. Instead, their income and expenses are passed through to their owners' income tax returns.
This rule most often trips up individuals who invest their IRAs in master limited partnerships (NYSEARCA:MLPS)-such as pipeline partnerships-or real estate partnerships. Master limited partnerships are traded on major stock exchanges, and many people think of them as being the same as corporate stock. In fact, these are limited partnership units, and the income and expenses of the partnerships pass through to the owners at tax time. When distributions from master limited partnerships to an IRA exceed $1,000, taxes are due on that income.
Individuals generally are urged not to purchase master limited partnerships through IRAs. Unlike collectibles, investments in MLPs and other pass-through entities can be held in an IRA. However, the ownership triggers the UBTI tax and the requirement to possibly file a version of Form 990 and pay estimated taxes.
When an IRA does own master limited partnerships and earns income of more than $1,000 for the year, some tax advisors recommend taking the easier and cheaper route of reporting any IRA-owned pass-through income on the IRA owner's individual tax return instead of preparing a separate return for the IRA.
MLPs are pass-throughs. Royalty trusts are pass-throughs. The question was asked about REITS - are they pass-throughs as well? I guess nobody knew because the question was never answered.
I wrote this so I would remember it - telling someone else always makes it more memorable for me. I didn't write it in my personal blog because it's about trucking; and I do all the html myself. It would have taken more time than I was willing to spend right now; and there are other matters I need to catch up on. So I decided to try this.
Important point for me here is that simply having a Roth IRA does not totally isolate me from tax free growth.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.