Tax Season – Is my IRA Subject to UBIT?

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With 2018 in the rear-view mirror, it may be time to starting thinking about the inbound tax filing deadline. Self-directed IRA investing can help make tax season a little more “fun” (did you get a nice tax deduction from your Traditional IRA contributions?), but your account may carry certain responsibilities depending on your IRA-owned alternative assets.

Specifically, your IRA may have to pay unrelated business income tax (UBIT) if it earned money through investments in an operating business or debt-leveraged property. Let’s explore this in more detail:

Does my IRA have to pay UBIT?

As mentioned above, your self-directed retirement plan will only have to pay UBIT under the following circumstances:

  • Your IRA earns unrelated business taxable income (UBTI) from a regularly carried-on trade or business, or it earns such income from a pass-through entity (for tax purposes). Some companies pay taxes on their corporate earnings before passing dividends/distributions to their investors. Others may issue payments directly to investors and bypass taxation at the corporate level. Investors must pay taxes (UBIT) on those earnings in the latter case, even if the "investor" is a tax-advantaged retirement account.

  • Your IRA earns unrelated debt-financed income (UDFI) from debt-financed property. This most commonly occurs with mortgaged real estate, but any real property (rental equipment, for example) can yield UDFI for a self-directed IRA. Your account will not have to pay UBIT on the full earnings balance; only earnings attributable to debt would incur UBIT. This could occur on an annual basis through income-producing assets like rental properties, or as a one-time transaction triggered by any outstanding debt that was in place within 12 months of a sale.

In either case, UBIT will only come due on annual net profits of $1,000 or more.

It looks like my IRA may owe UBIT. How do I file taxes on behalf of my account?

A pass-through entity would issue a Schedule K-1 for IRA investors to report the account's portion of the entity's annual profits. In Part III of the document, Box 1 describes ordinary business income, Box 2 describes rental income, and Box 3 describes non-real estate rental income. A properly prepared Schedule K-1 will also include a Code V in Box 20 to report UBTI for IRA investors.

If your IRA earns UBTI beyond $1,000, the IRS will require you to prepare and file a Form 990-T on behalf of your account to report the taxable earnings and pay any applicable UBIT. Always remember that UBIT payments must come from your IRA; you may not pay your IRA’s tax bill with personal, non-IRA money. Please see our Schedule K-1 blog and consult with your CPA or tax professional for more detailed information about this process.

What if my IRA took a loss on a UBIT-eligible investment?

As with any tax, your IRA would not have to pay the IRS if it takes a net loss on a UBIT-eligible investment. However, because a net loss in a given year may offset positive earnings in a future year, it may be worth filing the Form 990-T even if your account owes $0 in UBIT. For instance, if your IRA takes a $2,000 net loss in UBTI this year but nets a $5,000 profit next year, your IRA will only have to pay taxes on $2,000 (the $3,000 difference minus the $1,000 that the IRS disregards) as long as you report the net loss.

NDTCO’s sister company, IRA Tax Services, would be happy to assist you with filing a Form 990-T if your account owes UBIT for the 2018 tax year. For more information about self-direction and alternative IRA investments, please don’t hesitate to contact NDTCO at 877-742-1270 or info@ndtco.com.

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