UBIT, or unrelated business income tax, is a tax that can apply to otherwise tax-exempt entities, such as IRAs, 401(k)s, or nonprofit endowments, when they earn income from a trade or business that is unrelated to their exempt purpose. UBTI, or unrelated business taxable income, is the specific income subject to that tax. In real estate investing, this issue arises most often when a retirement account invests in a syndication or fund that uses debt financing, since the portion of income attributable to that leverage, known as debt-financed income, can trigger UBTI even though the account itself is normally tax-advantaged.
Investors funding a deal through a self-directed IRA should ask whether the underlying property or fund uses leverage, since an unleveraged all-cash structure typically avoids UBTI concerns entirely. When UBTI does apply, the retirement account, not the individual, is generally responsible for filing and paying the associated tax, which can meaningfully reduce the net benefit of holding leveraged real estate inside a tax-advantaged account.
Further reading: Inside a Cost Segregation Study: How a Building Becomes a Tax Shield for Its LPs
ACCESS
