What is UBIT?
Many IRAs make investments that do not incur tax (subject to specific rules). However, some IRAs make investments do incur tax that and Unrelated Business Income Tax (UBIT) is the name for the tax assessed.
How do I know if my IRA investments are subject to UBIT?
There are two scenarios that trigger unrelated business income tax for IRAs:Profits generated from a trade or business – When an IRA owns an ongoing business, tax on that business must occur. The tax can be taken at the company level before profits are paid to the IRA (in that case UBIT would not occur.) Or, the company can pay profits to the IRA before business taxes, at which point the IRA would be subject to UBIT. When an IRA or 401k derives profit from an operating business that has not paid business tax on those profits before distributing them to the retirement account, those profits are taxed at trust rates.
Leveraged real estate investments – When an IRA purchases real estate using a non-recourse mortgage loan, the debt financed portion of the property’s profits is subject to UBIT. Similarly, if an IRA-owned property is sold while a percentage of ownership is still debt financed, the profits derived from the debt financed percentage is subject to unrelated business income tax. In the case of debt leverage on real estate, UBIT is only calculated on the percentage of profits associated with the ownership percentage of the leverage. Expenses and depreciation can be used to minimize the profit calculation on the debt leveraged percentage of the property. The debt leveraged percentage is calculated as an average over the previous 12 months.
Leveraged real estate investments – When an IRA purchases real estate using a non-recourse mortgage loan, the debt financed portion of the property’s profits is subject to UBIT. Similarly, if an IRA-owned property is sold while a percentage of ownership is still debt financed, the profits derived from the debt financed percentage is subject to unrelated business income tax. In the case of debt leverage on real estate, UBIT is only calculated on the percentage of profits associated with the ownership percentage of the leverage. Expenses and depreciation can be used to minimize the profit calculation on the debt leveraged percentage of the property. The debt leveraged percentage is calculated as an average over the previous 12 months.
UBIT is calculated by filling out a form 990-T. It can be beneficial to fill out this form even if the IRA is not going to incur any tax, because losses can potentially be used to reduce profits in other years.
Please contact us if you need help calculating your UBIT or filing your Form 990-T.
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