Does refi in an IRA cause UBIT

[Marv Edelstein]

Purchasing a rental property with financing in an IRA creates a UBIT (Unrelated Business Income Tax) liability. However, If the IRA purchases the property with cash, then borrows to rehab, and then holds as a rental for 1-2 years will that also create a UBIT liability?

[Ashish Acharya]

Originally posted by @Marv Edelstein:

Purchasing a rental property with financing in an IRA creates a UBIT (Unrelated Business Income Tax) liability. However, If the IRA purchases the property with cash, then borrows to rehab, and then holds as a rental for 1-2 years will that also create a UBIT liability?

Yes, it does. What you are referring to is an Unrelated Debt-Financed Income (another type of UBTI). Post-acquisition debt is also a debt. 

Acquisition indebtedness, for any debt-financed property, is the unpaid balance of debt incurred by the organization [IRC Sec. 514(c)(1)]—

• 1. in acquiring or improving the property;
• 2. before acquiring or improving the property, if the debt would not have been incurred but for such acquisition or improvement; or
• 3. after acquiring or improving the property, if the debt would not have been incurred but for the acquisition or improvement, and the need to incur such debt was reasonably foreseeable when the property was acquired or improved. Whether the need to incur debt was reasonably foreseeable depends upon the facts and circumstances. Because an organization failed to foresee a need does not necessarily mean the need was not reasonably foreseeable [Reg. 1.514(c)-1(a)].

In general, income from debt-financed property used in an unrelated trade or business is treated as UBTI in proportion to the amount of debt-financing involved. The UBTI from the debt-financed property generally can be calculated by multiplying the income from the property by a fraction, the numerator of which is the average amount of “acquisition indebtedness” with respect to the property, and the denominator of which is the average adjusted basis of the property. Thus, a property encumbered with a proportionally larger share of debt relative
to equity will result in a greater amount of UBTI.