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In a few specific circumstances, an IRA may invest in such a way that it is required to pay Unrelated Business Income Tax (UBIT). It is the account holder’s choice as to whether the account invests in an asset that might incur UBIT. UBIT payments must always come from the account itself and never from your own pocket. An IRA or HSA will use an IRS Form 990-T to calculate UBIT. We recommend consulting with your accountant or tax professional.



What do these terms mean?


Unrelated Business Income Tax (“UBIT”) is often misunderstood by self-directed IRA investors and their professional advisors. In essence, UBIT is a tax that is due to an IRA when it receives “business income” as opposed to “investment income.”


Unrelated Debt-Financed Income (UDFI) is generated when an IRA borrows money to purchase real estate. UDFI is the result of Acquisition Indebtedness on the portion the IRA investment purchased using a loan.


Unrelated Business Taxable Income (UBTI) is income earned by a tax-exempt entity, such as an IRA, that is not related to the exempt purpose of the tax-exempt entity. The exempt purpose of an IRA is to provide for the retirement of the IRA holder.


When will my IRA incur UBIT?

Passthrough Business

Passthrough businesses don’t pay taxes at the corporate level; as the name suggests, they pass those taxes through to their investors. As such, if your self-directed retirement plan derives earnings (referred to as Unrelated Business Taxable Income or UBTI) from such a business, it will have to pay taxes on any income attributable to the investment.

Two other key points to bear in mind:

  • Your IRA will never have to pay UBIT if the business it’s invested in pays taxes at the corporate level.

  • There’s an important distinction between an asset and a company that makes money on an asset. For instance, your IRA could acquire land for oil extraction (no UBIT) or invest in a privately-traded oil company (possible UBIT).

Debt-Leveraged Property

If your IRA took out a non-recourse loan to purchase property, any earnings yielded from the leveraged portion of the asset (referred to as Unrelated Debt-Financed Income or UDFI) may incur UBIT. For example:

  • Your IRA holds a rental property. It paid cash for half and financed the other half (50%).

  • The rental property earns $10,000 in a given year. Since the debt percentage is 50%, half of those earnings ($5,000) will be taxed at the current UBIT rate.

The debt percentages from each of the previous 12 months will be averaged to represent the single debt percentage for that year. Profits garnered from the sale of a debt-leveraged property will also be subject to UBIT, but not at the current Trust Rate. Such profits would be taxed as capital gains.



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Investor’s Guide to UBIT

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