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How to Calculate Unrelated Business Income Tax (UBIT)

Do you think your Self-Directed IRA might owe UBIT? At iPlan group, we are constantly getting questions from clients and prospective clients about UBIT.

Let’s start by defining exactly what a UBIT is first.

Simply put, Unrelated Business Income Tax (UBIT) according to U.S. Internal Revenue Code is the tax on unrelated business income.  

This income is defined as coming from an activity engaged in by a tax-exempt 26 USC 501 organization that is not related to the tax-exempt purpose of the organization. 

What do I need to know about UBIT and my Self-Directed IRA?

In the case of a Self-Directed IRA, it’s primary purpose is to save for retirement, not to run a real estate business so this means that you should be declaring any income that you receive that is not being saved for your retirement as UBIT.

Take a look at your Self-Directed IRA and see if it’s been engaging in some non-traditional investment activities, it might. There’s no need to panic. With a little education, you can understand what causes UBIT and how to calculate it.

How do I know if UBIT applies to my Self-Directed IRA?

When a tax-exempt entity invests in an activity that is not substantially related to its tax-exempt purpose, any resulting income would be subject to the unrelated business income tax (UBIT). 

How do I know if it is income or growth?

For Self-Directed IRAs, anything other than an investment for the purpose of saving for retirement – typically passive investments – will likely result in UBIT. However, certain incomes from investments, such as rents, royalties, or gains from the sales of real estate owned outright by the IRA, are exempt from UBIT.

Your Self-Directed IRA is going to owe UBIT if it has carried out any of the following activities:

  1. Investing in an income-producing business, or investing in a pass-through entity such as a partnership or LLC that invests in an ongoing income-producing business.
  2. Conducting real estate transactions as an ongoing business activity rather than as passive investing, (Such as an ongoing Wholesaling or house flipping business).
  3. Using debt financing to make real estate investments.
  4. Other activities including making a significant number of private loans in a given year and using margin to purchase stock or securities

For most organizations, the following activity is considered an unrelated business and would be taxable if it meets three requirements

  1. It is a trade or business – which includes any activity carried on for the production of income from selling goods or performing services.
  2. It is regularly carried on – meaning if your activities in your organization show a frequency and continuity simlar to activities in nonexempt organizations. 
  3. It is not substantially related to furthering the exempt purpose of the organization  – this requires looking closely at the relationship between the activities that generate income and the accomplishment of the organization’s exempt purpose. 

Keep in mind, any UBIT tax is owed by the IRA, not by you as the account holder.  The IRA holds the investment.  So, the tax is paid from your IRA funds, not from your personal funds. 

How do I Calculate UBIT?

Calculating your UBIT starts with determining an investment’s net taxable income for a given year. 

If an investment produces income generated from eligible taxable activities, they are subject to an estimated tax of up to 37% on income over $12,750. Form 990-W is a worksheet provided by the IRS to determine the amount of estimated tax payments required.  A 990-T  is the additional form required when the IRA generates more than $1,000 or more of Gross Income from the unrelated business activity. (see irs.gov Internal Revenue Service. “Estimated Tax: Unrelated Business Income.” Accessed Nov. 22, 2019). 

Also, if an investment is leveraged, only the amount of income related to the financed portion of the investment is considered (a calculation for another discussion). Finally, only net taxable income over $1,000 for a given year will need to be reported.

Once you have a net taxable income, the amount of UBIT is calculated using the trust tax rates (per updates confirmed in Internal Revenue Bulletin (IRB): 2018-10) found in the following table:

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How to File for UBIT

If your Self-Directed IRA owes UBIT, the IRA must obtain a Federal Tax Identification Number (EIN) and file IRS Form 990-T, along with supporting forms and schedules, in order to report its taxable income. While it’s not necessary to file if taxable income is less than $1,000, in the event there is a loss Form 990-T must be filed in order to offset the loss against future gains.

For Self-Directed IRAs and other retirement plans, Form 990-T must be filed by April 15th of each year, although it is possible to file a request for extension. Any payments would be made to the IRS through the Electronic Federal Taxpayer Payment System (EFTPS).

Be Familiar with UBIT Rules

It’s important for IRA owners to be educated about their investments, particularly the more complex alternatives available to Self-Directed IRAs, and the relevant tax consequences.