If there ever was a subject that will stop an accountant in his or her tracks, it’s unrelated business income tax (UBIT). Some investors avoid certain investments out of fear of UBIT, but these investors may simply be misinformed about the tax.
Questions about UBIT? Click here to download our UBIT Guide.
To start, UBIT aims to “level the playing field” for certain businesses. The competition between a non-profit and a for-profit enterprise illustrates the purpose of UBIT. The college bookstore sells books to students and others within the structure of their “non-profit” umbrella. The college bookstore, as a non-profit, pays lower taxes than a for-profit enterprise. A non-profit is not taxed on most operations and therefore can sell books at a lower cost than for-profit competitors.
Unrelated Business Income Tax
This is where UBIT comes into play. The government has placed a tax burden on the non-profit enterprise for running a business under the main business of running a college. This same philosophy and set of rules are applied to an IRA’s investment in real estate when there is debt related to the purchase of that real estate. So what is bothering the accountants among us?
- The tax rate for UBIT is high, ranging from 26% to 34%
- Calculation of this tax is, for those not familiar with the rules, complicated
These issues are resolved, however, when the investor realizes that the tax can allow for greater overall gains. When debating the pros and cons of using leverage within an IRA to purchase an income property, the questions could be “How much will the IRA grow using debt leverage and paying UBIT?” and “What is the resulting rate of return within my IRA?” rather than “How do I avoid UBIT altogether?” The other due diligence items such as the physical condition of the property as well as questions on the ability of the cash stream to service the loan and pay expenses, including UBIT, should also be taken into consideration.
Dismissing an investment because of the potential payment of taxes could be premature. Consult with your legal and tax advisors regarding investments involving potential UBIT within your IRA.