UBIT only applies to property held

Question

Seems to me, reading the instructions for form 990-T, that UBIT only applies to assets held less than a year. In the instructions for Line 4aâ€”Capital Gain Net Income, the IRS says:

Generally, organizations required to file Form 990-T (except organizations described in sections 501(c)(7), (9), and (17)) are not taxed on the net gains from the sale, exchange, or other disposition of property. However, net capital gains on debt-financed property, capital gains on cutting timber, and ordinary gains on sections 1245, 1250, 1252, 1254, and 1255 property are taxed. See Form 4797, Sales of Business Property, and its instructions for additional information.

So ordinary gains on rental property are taxed. Ordinary Gains and Losses are specified on Part II of form 4797, and the instructions (http://www.irs.gov/pub/irs-pdf/i4797.pdf) say to use 1 year as the cutoff for Ordinary Gains and Losses.

Seems like selling a property held by a SDIRA account for a year or more will result in no UBIT exposure. I bring this up because I don't necessarily want to sell now, but most likely 2-3 years form now.

Will Barnard · Answer

UBIT can also be triggered if you use debt financing, but if your IRA pays off the debt first, then holds for 365 days, the UBIT goes away on that too.

Chris Martin · Answer

Charles, thanks for the response. Consistent with the IRS instructions, the article also says "Some examples of exempt income to an IRA would include interest from loans, dividends from securities, real estate rental incomes and the proceeds of the sale of real estate that was held for appreciation." The article also lists the most common tests used to determine passive investment vs. business activity, two of which include Intent and Holding Period.

My plan is to rent a property to a tenant who may want to buy the property down the road. Not a lease option, but potentially a purchase with owner financing via the SDIRA account. The IRA would provide the deed take a longer term note, collecting mortgage payments rather than rent payments. I'm thinking 12 months of on-time rent payments may be required before even considering a sale to the tenant. At this point, I'm not worried about UBIT.

Jon Holdman · Answer

Rental income and profits from the sale of a debt financed property in a traditional IRA are subject to UBIT.  There is an exemption from UBIT for rental income and for profits from sales of investment (nor development or fix-and-flip) properties.  But then there is an exemption to the exemption for debt financing.

You compute a fraction, which is the amount of debt divided by the basis.  That fraction of the rental income or the gains on a sale subject to UBIT.  Notice the denominator is the basis.  And remember that the basis is reduced by deprecation that is taken or allowed, whichever is greater.

I have explicitly verified both these points with the attorney who helped me setting up my SDIRA.

Account Closed · Answer

Here is a quote from an article that might help explain this a little better.  UBIT can be quite confusing.

http://www.wiki-investor.com/page/UBIT+-+When+does+it+apply%3F

Kevin K. · Answer

I just read pub 598, and my understanding is that only acquisition indebtedness triggers UBTI (page 14).  Debts that are not acquisition indebtedness include real property debts of qualified organizations (page 16).

Is an SDIRA a qualified organization?  If it's a qualified retirement plan under 401(a), then yes.

My take would be that a debt financed property held by an SDIRA would not have income UBTI.

Anyone else get see it like I do?  or am I way off?

wow! I would have never guessed my first post would be something like this...

UBIT only applies to property held <12 months?

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