UBIT & UDFI

Potential Taxes with Self-Directed IRAS

UBIT and UDFI are taxes your self-directed IRA may incur when borrowing funds to invest and/or if running a business as an investment in your plan. It is important to understand the two and to know how they work to follow IRS guidelines.

UBIT TAX

Unrelated Business Income Tax (UBIT) occurs when your self-directed IRA invests into a private entity and receives shares of business profits instead of tax-free dividends. This tax also applies to gains made by a business your IRA owns and operates.

UDFI TAX

Unrelated Debt-Financed Income (UDFI) tax occurs when your IRA purchased real estate using financing like a non-recourse loan. The percentage of income attributed to the portion owned by your IRA is tax-sheltered. But the percentage of income generated on the financed portion is subject to UDFI tax.

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Your IRA may owe tax if

  • UBIT: It receives income through a business operation or entity (such as a partnership or an IRA LLC) that did not pay business tax on the profit before distribution to the retirement account.
  • UDFI: It used financing and earned income that can be attributed to the debt-financed portion of the asset. Any expenses and depreciation of the property can be calculated to offset the tax liability.

Considerations with UBIT & UDFI tax

  • UBIT does NOT apply to investments into C-Corporations as the C-Corporations pay tax at the corporate level and pass along dividends to your IRA.
  • Rents, interest, and dividends received from investments are not subject to UBIT
  • If your self-directed IRA is subject to UBIT or UDFI, the tax must be paid with your self-directed IRA funds.
  • If the tax applies, your IRA may be able to use other deductions to reduce the impact of the UBIT.

 

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While UBIT is explained in IRS Publication 598 and IRC 514 explains UDFI, you should consult with your accountant or other tax professional, to ensure your IRA remains in compliance with IRS guidelines.