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UBIT (Unrelated Business Income Tax):

How it Affects Your Self-Directed IRA

Unrelated Business Income Tax UBIT:
Tax information Alternative Investors Should Know

Self-Directed IRAs provide the opportunity to invest in a variety of alternative assets, such as real estate, precious metals, and small businesses, within a tax-advantaged account. The profits made from Self-Directed IRA investments are generally tax-deferred or tax-free, due to the “passive” nature of the investments. However, if you invest a Self-Directed IRA in an active business as defined by the IRS, then you'll need to know about UBIT; taxes may apply to your profits.

What is UBIT in an IRA?

Unrelated Business Income Tax, or UBIT, applies to the profits of an active business owned by a tax-exempt entity such as a qualified retirement plan. For example, if an IRA invests in an unincorporated active business (such as a gas station, grocery store, etc.), the net income profit generated is subject to UBIT.  

UBIT and UBTI are often used interchangeably.

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UBIT (Unrelated Business Income Tax)
The tax owed based on the unrelated business income received by the tax-exempt account or entity.

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UBTI (Unrelated Business Taxable Income)
The type of income that is taxable from an active business investment in your Self-Directed IRA.

Why was UBIT Created?

A group of investors peruse through their materials to determine their annual unrelated business income tax or UBIT tax rate.
Congress created UBIT to even out the competition between not-for-profit and for-profit organizations that operated the same type of business. Without unrelated business income tax rules, not-for-profit organizations had the unfair advantage of not having to pay the income taxes that for-profit organizations were subject to, allowing them to charge less for the same products and services.

Do Self-Directed IRAs Have to Pay Unrelated Business Income Tax?

Most alternative assets in Self-Directed IRAs never have to pay UBIT because the investments are passive in nature and tax-deferred (or tax-free within a Self-Directed Roth IRA). However, UBIT applies in the following scenarios:

The first is when a tax-exempt organization or entity, such as a non-profit organization or IRA/Solo 401(k), invests in an unincorporated operating business (such as an LLC that sells goods or services). The income that flows from the LLC to the IRA is ordinary income and, therefore, is subject to UBIT. 

UBIT also applies to an IRA that uses debt financing to buy an investment, such as a loan on a real estate property. The income attributable to the loan, known as Unrelated Debt-Financed Income (UDFI), is subject to UBIT. 

An investor speaks with his financial advisor, happy to confirm that he will not owe any unrelated business income tax - or UBIT - this year.

When Does UBIT Apply?

Here is a breakdown of common IRA investment income types that require or are exempt from UBIT.

Table 1: IRA Investment Income and UBIT
Income Type
Require UBIT
Exempt from UBIT
Income Type
Rental Income
Require UBIT
Exempt from UBIT
Income Type
Interest Income
Require UBIT
Exempt from UBIT
Income Type
Dividend Income from a C-corporation
(most publicly traded companies)
Require UBIT
Exempt from UBIT
Income Type
Royalty Income
(income from intangible property rights)
Require UBIT
Exempt from UBIT
Income Type
Capital Gains 
(from the sale or exchange of property in the long-term)
Require UBIT
Exempt from UBIT
Income Type
Debt-Financed Income
Require UBIT
Exempt from UBIT
Income Type
Income generated from unrelated business activities
Require UBIT
Exempt from UBIT
Income Type
Income generated from an unincorporated active business 
(e.g. sale of goods/services)
Require UBIT
Exempt from UBIT

Do you have any questions about UBIT?

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Does UBIT Apply To My Real Estate Investment?

UBIT applies to real estate investments that either are debt-financed or undergo a short-term flip. 

Ask these questions to see if UBIT applies to your Real Estate IRA investment:

1

Objective: Did you purchase the property to serve as a long-term investment or to be flipped and sold immediately?

2

Time Frame: Did you hold the property for more than a year? The longer the property is held, the more likely it is to be deemed held for investment and therefore not cause UBTI. 

3

Property Improvements: Did you purchase, develop, and sell the property? The less work done on the property, the more likely it is held for investment purposes.

4

Debt-Financed:  Did you use a loan to help purchase your property? If yes, the portion of the investment that was funded by the loan is subject to UBIT. 

For example, if a property is purchased with 50% IRA funds and 50% through a loan, the amount subject to UBIT would be 50% of the net income earned from the property (through rental income or capital gains) after subtracting the first $1,000 and any deductions (expenses, tax, depreciation, etc.).

What Investment Choices Do I Have?

UBIT should not necessarily deter you from investing your Self-Directed IRA in alternative assets. Many investors miss out on profitable opportunities because they are unfamiliar with UBIT. Investing in both alternative assets and traditional investments can create a diversified portfolio and opportunity to increase IRA funds. There are also tax write-offs, such as depreciation, that limit the amount of UBIT owed.

This investor is thrilled by the alternative investment opportunities she encountered which aided in lowering the amount of annual UBIT (unrelated business income tax) that she owed.

How To File for UBIT

UBIT or Unrelated Business Income Tax is the topic of discussion for these investors during their monthly meeting.
To report and pay UBIT, the IRA must file IRS Form 990-T by April 15. If the annual gross UBIT income exceeds $1,000, the IRA must report and pay UBIT. UBIT is paid with IRA funds, not the IRA owner's personal funds. Some states may have their own paperwork for UBIT. Contact a financial advisor to see if this applies to your state.

How To Calculate UBIT

When calculating UBIT, the tax rate depends on the annual income received.

Table 2: UBIT Tax Rate 2024

Annual Income
UBIT Tax Rate (2024)
Annual Income
$0 – $3,100
UBIT Tax Rate (2020)
10%
Annual Income
$3,100 – $11,150
UBIT Tax Rate (2020)
$310 + 24% of the excess over $3,100
Annual Income
$11,150 – $15,200
UBIT Tax Rate (2020)
$2,242 + 35% of the excess over $11,150
Annual Income
Over $15,200
UBIT Tax Rate (2020)
$3,659.50 + 37% of the excess over $15,200

*Please note that tax rates may vary.

Assume a Self-Directed IRA invested in a grocery store that is an LLC and received a K-1 for $50,000 of net taxable income for the LLC for that year. 

1

Find the excess amount: $34,800 ($50,000 minus $15,200).

2

Calculate 37% of the remaining $34,800, which equals $12,876.

3

Add in $3,659.50. The total tax due is $16,535.50 ($12,876.50 plus $3,659.50).

4

The after-tax net amount the IRA would keep is $33,464.50 ($50,000 minus $16,535.50 in UBIT).

How To Avoid UBIT

There are two options that may be used to avoid UBIT. A tax professional or financial planner can help you understand your options.

Blocker Corporations
Corporate tax rates are significantly less than UBIT rates. Because of this, an IRA may benefit by establishing a 100% owned C-corporation, which the IRA invests in and receives ordinary income from. In this case, a C-corporation is used to "block" UBIT from being owed by the IRA in exchange for a lesser corporate tax. 

For example, if an LLC reports $50,000 of net taxable income to a Self-Directed Roth IRA, if the IRA needs to pay UBIT, the tax bill would be $16,535.50. However, if the same ordinary-income business paid $50,000 in profits to a C-corporation that was owned 100% by an IRA, the C-corporation would only pay $10,500 (based on the corporate tax rate of 21%).

By implementing a blocker, you can greatly reduce your amount of Unrelated Business Income Tax owed.
A retired couple enjoy a casual rendezvous on a boat, delighted that they save so much annual income by evading unrelated business income tax (UBIT).

Offshore Corporations
Foreign corporations often have much lower corporate income tax rates than in the U.S. However, a foreign corporation blocker company is a very complex structure and should only be considered after adequate due diligence.

Speak with a Specialist

In all cases, self-directed investors should contact a financial professional to understand the rules and taxes incurred by their investment. For more clarification, reach out to a Self-Directed IRA Specialist.
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