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UBIT, UDFI & UBTI

Understanding how Unrelated Business Income Tax (UBIT), Unrelated Debt-Financed Income (UDFI), and Unrelated Business Taxable Income (UBTI) is calculated and applied to investments can help you make informed decisions in managing your self-directed account. 

It is the account holder’s choice as to whether the account invests in an asset that might incur these taxes. However, these taxes should not be seen as a deterrent, as they do not have to be complicated or costly. 

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At a Glance

What do these terms mean?

WHAT IS UBIT?

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.”

WHAT IS UDFI?

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

WHAT IS UBTI?

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.

Understanding UBIT

When will my investment incur UBIT?

Passthrough Business

Passthrough businesses don’t pay taxes at the corporate level— they pass those taxes through to their investors. If your self-directed account derives earnings (Unrelated Business Taxable Income or UBTI) from such a business, it will have to pay taxes on any income attributable to the investment.

Important to keep in mind:

  • Your IRA will never have to pay  UBIT if the business it has invested in pays taxes at the corporate level.
  • It is important to distinguish 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 account took out a non-recourse loan to purchase property, any earnings yielded from the leveraged portion of the asset (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.

Explore the downloadable UBIT Calculator to learn more about UBIT and how it may impact your real estate investments

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Investor’s Guide to UBIT

Click to download our Investor's Guide to Unrelated Business Income Tax (UBIT)
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