What is UBIT? Is it only for SD IRA?

17 Replies

Most of my RE is invested through my Self Directed Solo 401k. 

I've seen the term UBIT thrown around, but don't fully understand it. I don't think it affects my  life, so that's good but I want to know about it anyway.

Tagging @Dmitriy Fomichenko who seems to know everything...

It applies to 401ks as well the only exception is Real Estate in a 401k.

Feel free to ask your specific questions.

Mindy,

UBIT stand for Unrelated Business Income Tax and applies on any income in your 401k that would derive from active trade or business. Passive investments (rental real estate, trust deeds, tax liens, private business, private lending, etc.) would be exempt from this tax. 

Example of active trade or business would be: franchise business owned in by your 401k, flipping done in your 401k.

In an IRA UBIT would also apply on income from leveraged property, but the 401k is exempt from this.

Here is more on this subject from the IRS:

https://www.irs.gov/charities-non-profits/unrelate...

Originally posted by @Dmitriy Fomichenko :

In an IRA UBIT would also apply on income from leveraged property, but the 401k is exempt from this.

Here is more on this subject from the IRS:

https://www.irs.gov/charities-non-profits/unrelate...

Dmitriy, it this last part of your answer, do you mean UDFI instead of UBIT, or am I misunderstanding?

I dont want others to be confused as taxation in Self Directed accounts is confusing enough already ;-)

Thanks for all you, and other plan providers on here also, do for the BP Community.

Dan Dietz

UBIT rules for IRAs come largely from rules that apply to non-profits. For IRAs, UBIT may need to paid to the IRS from the IRA itself in a few scenarios.

1. If your IRA uses debt to secure a property, the net profit associated with that year's average debt percentage may incur UBIT if that profit is more than $1,000. (the income is called UDFI - Unrelated Debt Financed Income)

2. If your IRA sells a property that still has outstanding debt on it, UBIT may apply to part of the profit.

3. If your IRA owns an ongoing, revenue producing business that is not "housed" within a C-Corp. or other taxable entity, then the business tax is paid at the IRA level in the form of UBIT. (the income is called UBTI - Unrelated Business Taxable Income).


Broadly speaking, Solo 401(k)s do not have to pay tax (UBIT) on UDFI, but, generally, would pay tax (UBIT) on UBTI.

Originally posted by @Daniel Dietz :
Originally posted by @Dmitriy Fomichenko:

In an IRA UBIT would also apply on income from leveraged property, but the 401k is exempt from this.

Here is more on this subject from the IRS:

https://www.irs.gov/charities-non-profits/unrelate...

Dmitriy, it this last part of your answer, do you mean UDFI instead of UBIT, or am I misunderstanding?

I dont want others to be confused as taxation in Self Directed accounts is confusing enough already ;-)

Thanks for all you, and other plan providers on here also, do for the BP Community.

Dan, I meant exactly what I wrote: In an IRA Unrelated Business Income Tax will apply on income from leveraged property. Such income would be called Unrelated Debt Finance Income (or UDFI). But the tax that the IRA would owe on UDFI is still UBIT.

@Mindy Jensen & @Daniel Dietz

Yes, the alphabet soup associated with taxation inside a retirement plan is confusing enough itself, nevermind the actual tax issues.

UBIT stands for Unrelated Business Income Tax, and is the tax applied to various forms of tax exempt entities in certain situations.  See IRS Publication 598.

UBTI stands for Unrelated Business Taxable Income. This is income subjected to taxation when a tax-exempt entity engages in a trade or business on a regular or repeated basis. In the real estate space, this generally involves more active dealer style transactions such as flipping, wholesaling or new construction for sale. When an IRA has exposure to UBTI, it will pay UBIT.

UDFI stands for Unrelated Debt-Financed Income, and is a subset of UBTI. UDFI applies when a tax-exempt entity uses debt-financing such as a mortgage. The percentage of the income that the IRA receives that is attributable to the borrowed funds is taxable. IRA plans are generally subject to UDFI. A 401(k) is exempted from UDFI when the debt is associated with the acquisition of real property, but subject to UDFI for other forms of leveraged investments. When an IRA has exposure to UDFI, it will pay UBIT.

Always learning! Great Thread!

Would it be better for your self-directed 401k or IRA to be more of a credit facility rather than the actually purchaser?

meaning, should i borrow money from my SD IRA and then pay it back with interest? or should i buy the home using the SD IRA and then be subject to UBIT?

@Marshall Hooper ,

You personally can not borrow from an IRA. You can borrow from a 401k, but the loan is limited to 50% of the balance or $50K, whichever is less.

You can invest using your SD IRA in a property, or you can use your IRA/401k as a bank and lend money to others. This is a great way to put your retirement funds to work!

Thanks for the clarification guys. I cant imagine learning all this without all of your help and patience!

Dan Dietz

Originally posted by @Dmitriy Fomichenko :

@Marshall Hooper,

You personally can not borrow from an IRA. You can borrow from a 401k, but the loan is limited to 50% of the balance or $50K, whichever is less.

You can invest using your SD IRA in a property, or you can use your IRA/401k as a bank and lend money to others. This is a great way to put your retirement funds to work!

I guess that means there's no loophole allowing me to loan money to a LLC that I own instead? Or may loaning to someone else to his partnering with me on a deal?

@Marshall Hooper ,

Yes you are correct, there are no loopholes for you to personally benefit from the use of your IRA funds. That is a defenition of a "Prohibited Transaction" and will result in disqualification of your IRA.

You are considered to be a "Disqualified Person" to your IRA. As such you must personally stay away from those transactions as far as possible. This is called "arms length".

You can learn more here:

https://www.irs.gov/retirement-plans/plan-particip...

Originally posted by @George Blower :

@Marshall Hooper

One option is to take a solo 401k participant loan and use those funds for any purpose including investing them in your own LLC, since once borrowed, the funds are no longer considered solo 401k funds.

i'm under the impression that a Solo 401k is for those who are self-employed? if you mean a loan from my companies 401k, then it would be a good idea, but my employer is a french-start up and they are still learning what it means for Americans to have to save for their own retirement. :)

@Marshall Hooper

That is correct regarding the solo 401k plan. Yes you could also borrow from your existing employer's 401k plan if the plan allows for it.

Both IRAs and Solo 401ks can be subject to UBIT on business activity and UDFI tax on debt leveraged assets. The Solo 401k is exempt from UDFI tax only on real assets.

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