Self-Directed IRA

UDFI (Unrelated Debt Financed Income)

UDFI (Unrelated Debt Financed Income)

What is UDFI?

Unrelated Debt Financed Income, or UDFI, occurs when an IRA or LLC in which an IRA has an ownership interest, borrows money to purchase real estate. (This is also known as using leverage or debt-financing.) The net profits attributable to the leveraged portion are considered UDFI and are subject to a UDFI tax. For example, if a real estate property is purchased with 50% IRA funds and 50% borrowed money, half of the total profit earned is subject to UDFI tax.

UDFI is a subset of UBIT (Unrelated Business Income Tax). The borrowed money is considered "unrelated" to the IRA because it is not taken from the IRA funds. If your investment is subject to UDFI tax, it is paid at the UBIT tax rate. Only one tax payment is due, even if UBIT and UDFI tax are required, because it is the same income being taxed. 

How Do I Calculate UDFI?

Let us assume an IRA LLC purchases a property for $100,000 using $60,000 from the IRA’s funds and $40,000 from borrowed money. The property earned a net profit of $50,000 and deductions for the year are $3,000.

To calculate UDFI, follow these steps:

1. Determine the ratio of debt versus the cost of the property.
Divide the amount of funds borrowed to purchase the property by the cost of the property ($40,000 / $100,000 = 0.4 or 40%). The ratio of debt versus the cost of the property is 40%.   

2. Calculate the amount of income subject to UDFI tax (before deductions).
 Multiply the net profit by the ratio of debt versus the cost of the property ($50,000 x 40% = $20,000). $20,000 is subject to UDFI, before deductions.  

3. Determine the amount of income subject to UDFI (after deductions).
 Subtract $3,000 from $20,000.  

4. After deductions have been taken out, the remaining net amount is subject to UDFI tax.
$17,000 is subject to UDFI tax.

Use the IRS tax rate schedule for trusts and estates to figure out your tax bill (refer to page 5 on Form 990-W).

How Do I File for UDFI?

Your accountant or tax preparer will determine whether UDFI taxes are owed. If UDFI tax is due, the account holder is responsible for preparing Form 990-T.

It is recommended to contact a financial professional to discuss the rules and taxes incurred by your Self-Directed IRA investment. For more clarification, regarding UDFI or UDFI tax, reach out to a Self-Directed IRA Specialist.

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