“Dear John, I’ve been researching self-directed IRAs and the issue of UBIT keeps coming up. How can UBIT affect my IRA?”
Thanks for your question, Tina. UBIT is a complex issue and one that’s worth speaking with your tax advisor. The issue of UBIT is also notorious for not necessarily having hard and fast rules regarding how it is applied to each specific situation. I won’t be able to cover everything in a single response, but I’ll try to give you some introductory information on the topic.
UBIT is an acronym for “Unrelated Business Income Tax”. It is a tax the IRS places on an organization that is normally tax-exempt to the extent that the profits for that organization are being made from an endeavor
(or business activity) not related to its initial purpose. A commonly used example for this is a University, which is usually tax-exempt, opens a restaurant for both students and non-students alike. Normally, your IRA is also completely tax-free or tax-deferred, but how UBIT comes into play can be nuanced.
For any given situation, I would most likely not be able to give you a definite “yes” or “no” regarding whether UBIT would be triggered, but I can shed some light on situations where it is more likely.
The primary situation where UBIT comes into play is when you receive a non-recourse loan to help fund a purchase within your IRA. In these situations, the IRS can treat your IRA as a flow-through entity. Essentially, the IRS is saying at this point that your IRA is being used as a business rather than a retirement savings account. In fact, this can effectively be their justification for triggering UBIT in other situations. This is why the consistency or regularity plays a part. If you flip one home a year, you’re unlikely to trigger UBIT. However flipping 3-5 homes may be enough for the IRS to essentially say you’re running a business and therefore trigger UBIT.
As for whether a deal, or series of deals, is worth it within an IRA given the possibility of UBIT as compared to regular capital gains is between you and your tax advisor. Everyone’s situation is different but I’ve spoken to numerous Equity Trust clients who feel UBIT or the possibility of it being triggered, are not hindrances worth slowing down their deals or warranting a distribution, especially when they consider capital gains taxes by comparison and the amount of money they’ve been able to grow within their IRA.
We’ve really only scratched the surface on what is truly a nuanced topic but hopefully this gives you some insight into the basics of what UBIT is and how it could affect you. Thank you again for your question, Tina!
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