What is UBTI?
What is UBTI and How it Affects Investing Within Self-Directed IRA and Solo 401k?
Unrelated Business Taxable Income (UBTI) is defined by the IRS as the income generated by regular business activity that is unrelated to the main purpose of a tax-exempt entity. If the business activity is regular, funded by the tax-exempt entity (such as Self-Directed IRA or Solo 401k, and unrelated to the main purpose of the entity, the income generated by that activity is designated as Unrelated Business Taxable Income.
The IRS defines Unrelated Business Taxable Income as meeting the following three requirements:
1. It is a trade or business
2. It is regularly carried on
3. It is not substantially related to furthering the exempt purpose of the organization
UBTI is Subject to UBIT
Unrelated Business Taxable Income inside of Self-Directed IRA or Solo 401k is subject to taxation. This taxation is called Unrelated Business Income Tax (UBIT) and is a complex and compressed tax rate schedule.
The UBTI and UBIT were developed to ensure a level playing field between non-profit and for-profit businesses. They were created to prevent non-profit organizations from having an unfair advantage due to their tax-exempt status over for-profit organizations. The IRS designed the UBTI rules to allow for fair competition.
UBTI can apply to Self-Directed IRA and Solo 401k
Although the rules for UBTI were designed for non-profit businesses and charitable organizations, they also apply to retirement accounts such as IRAs and Solo 401k. Both are tax-exempt entities, but certain types of income received within retirement accounts can be subject to Unrelated Business Income Tax. If the IRA/401k is used to make investments that generate income from unrelated business activity, that income may be subject to UBIT.
Examples of IRA or Solo 401k investments that may trigger UBIT include:
- Debt-financed investments, such as using a margin loan to purchase stocks
- Ownership of pass-through entities, such as limited partnerships and LLC, that generate business income
- Purchasing property using a non-recourse loan (Solo 401k is exempt from this)
Filing Form 990T is required if the Unrelated Business Taxable Income amounts to $1,000 or higher within a tax year. The IRA or Solo 401k account owner has the responsibility to file the form on or before the April 15 deadline. Payments must be made from the retirement account and the plan custodian must be directed to make these payments before their due date.
For additional resources please refer to the IRS website: