Many investors are afraid of acting on money-making opportunities because they think UBIT is a penalty or an excessive tax. However, UBIT typically means that—in the case of retirement accounts—the account is making money. It is not a penalty, just a way to even the playing field between tax-exempt and tax-deferred entities like a retirement account and other entities/people.
To get a basic understanding of UBIT and Unrelated Business Taxable Income (UBTI) and Unrelated Debt-Financed Income (UDFI), that two types of income that may be assessed UBIT, let’s go straight to the source: the IRS. The IRS Publication 598 outlines what these tax consequences are and how you’ll incur them.
Below are some excerpts from the IRS that may help an IRA holder to understand the parameters.
Unrelated business income - Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity.
Income - Generally, unrelated business income is taxable, but there are exclusions and special rules that must be considered when figuring the income.
Exclusions - The following types of income (and deductions directly connected with the income) are generally excluded when figuring unrelated business taxable income.
- Dividends, interest, annuities and other investment income - All dividends, interest, annuities, payments with respect to securities loans, income from notional principal contracts, and other income from an exempt organization's ordinary and routine investments that the IRS determines are substantially similar to these types of income are excluded in computing unrelated business taxable income.
- Royalties - Royalties, including overriding royalties, are excluded in computing unrelated business taxable income.
- Rents - Rents from real property, including elevators and escalators, are excluded in computing unrelated business taxable income.
- Exception for rents based on net profit - The exclusion for rents does not apply if the amount of the rent depends on the income or profits derived by any person from the leased property, other than an amount based on a fixed percentage of the gross receipts or sales.
Unrelated Debt-Finance Income
Income From Debt-Financed Property
Investment income that would otherwise be excluded from an exempt organization's unrelated business taxable income (see Exclusions under Income earlier) must be included to the extent it is derived from debt-financed property. The amount of income included is proportionate to the debt on the property.
Debt-Financed Property
In general, the term “debt-financed property” means any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness at any time during the tax year (or during the 12-month period before the date of the property's disposal, if it was disposed of during the tax year). It includes rental real estate, tangible personal property, and corporate stock.
If you have any questions about UBIT, UBTI or UDFI, feel free to contact us at NDIRA by visiting www.ndira.com and giving us a call, email or chatting online with an IRA expert.
(Information provided by the IRS publication 598.)
