I came across these paragraphs today and remembered our discussions here. I believe that they are well written and informative. Here they are verbatim, without further commentary from me:
What is UBTI and how is it different from UBIT?
UBTI is an acronym for Unrelated Business Taxable Income. UBTI generally occurs when a plan generates income from operating a business, acquiring or improving property through debt financing, or certain partnerships from which the plan owns an interest.
UBTI is income generated by a trust when engaging in business activity that is unrelated to its general purpose. Self-directed IRAs were created for long term investing, and when it purchases an asset that produces income unrelated to the intent of the plan then that income is subject to taxation which means your IRA will be paying taxes on profits generated from your business purchase.
UBTI is subject to Unrelated Business Income Tax or UBIT. UBIT is a very steep and complicated form of taxation. Much like Federal Income Taxes, UBIT is set to a laddered schedule. However it is compressed on much tighter levels. In 2005, UBIT is taxed at the following rates:
UBIT was implemented to keep the playing field even between plans that open businesses and the typical small business owners. If a plan or self-directed IRA was able to purchase a business and did not have to pay any taxes, it would be able to deliver an identical product at a discount. UBIT mitigates that risk for the typical business owner.
UBIT is one of the most complicated areas of taxation in the Internal Revenue Code. It is imperative you seek professional help to make sure you do not incur any severe tax penalties.
What is UDFI?
UDFI stands for Unrelated Debt Financed Income. UDFI is income generated by an IRA, or other retirement plans, through debt-financing or leverage. UDFI is taxed much like UBTI and is similarly as complicated. UDFI only applies to the profit realized through debt and is based on the highest amount of leverage carried within the past 12 months. Refer to IRC § 514(a) (1).
For example: Your self-directed IRA purchased a piece of raw land in 1999 for $100,000 using a non-recourse loan with 50% down. In 2004, you sold that same piece of property to a developer for $200,000. Your IRA had secured a 50% loan to value (LTV) on the property, and lets assume that you never paid down any principle because it was an interest only note. Fifty percent of the profit would be subject to UBIT because it was generated by money that was not related to the self-directed IRA.
As a side note UDFI does not apply if the debt is paid off 12 months prior to the sale of the property. If the self-directed IRA can pay off its loan early it may not have to pay UBIT at all! If you are intending to purchase assets inside a self-directed IRA using debt-financing, please consult with a competent tax advisor.
Quotes of the day:
It just isn't worth having your IRA disqualified because your greed is bigger than your brain.
Your IRA is much too important for you to step over the line and violate the governing rules.
Self-directed IRAs were created for long term investing, and when it purchases an asset that produces income unrelated to the intent of the ?plan? then that income is subject to taxation
Traderstatus, I'm not asking for advice just your personal opinion on this question:
With regard to the above quote, how would you classify buying and selling futures contracts inside an IRA? We're not talking stocks here, only futures. Outside the IRA, let's say the person is buying/selling futures in a regular futures account and filing tax returns as an investor using Form 6781 for his futures profits, which means they are being declared as capital gains subject to 60/40 tax treatment.
For such a futures 'investor' who also has an IRA in which he daytrades futures contracts ...are you suggesting that the tax-free status of the IRA might be disqualified? If so, what is your rationale? The purpose of trading in the IRA is for long-term capital appreciation for retirement, so who cares how often a person buys/sells? Futures contracts do not in and of themselves generate income.
You know what ...maybe filing as an investor for regular trading profits (instead of trader status) might guarantee the IRS doesn't think anything odd about the capital gains in your futures IRA. Perhaps it is declaring trader status for regular futures trading that risks geting the profits in your futures IRA seen as UBTI. Maybe those 'investors' are onto a good thing?
There are plenty of people who want to actively trade stocks or futures in their IRA in addition to outside the IRA. But if they file trader status thereby declaring their non-IRA activity to be "income" then perhaps the IRS could say "well then, it's bloody well income inside the IRA too" and disqualify the tax status of the IRA. In other words the IRS might say to the person: "listen Mr. Trader, you can't tell me on the one hand that you sit at your screen all day and are a trader with income doing this for a living ...and then turn around and tell me that the same activity in your IRA account is a long-term investment. You can't have your cake and eat it too."
This appears to be a serious problem. Trader tax firms have been selling the benefit of trader tax status to their active daytrading clients for years. The ability to daytrade in an IRA is fairly recent. If those daytrading clients suddenly start losing the tax-emempt status of their IRAs, and the reason was because they declared themselves to be traders with 'income' outside the IRA ...then the trader tax firms are going to be faced with a mass of very pissed off customers.
What benefit would it be to declare trader status to write off that seminar expense, if a by-product is that the IRS later shreds apart your IRA with tax and penalties? The Trader Tax firms need to get this issue sorted out FAST. In the meantime, "investors" are looking better by the minute with their safe tax-free IRA accounts ...
this discusioion is getting way far out of hand. i had a friend who daytraded his 200k ira for a living back in 1997 before the days of not being able to daytrade ira's. one msut remeber you're hit hard with the 10% penalty and paying full taxation for taking out withdrawels. also you can't write loses off? he ended up losing 1/2 his ira in 18 months. I'D SAY WITHOUT HESITATION IF THE IRS EVER EVVEN LOOKED AT THIS IT WOULD BE FROM SOMEONE SOLEY TRADING THERE IRA AND TAKING SYSTEMATIC WITHDRAWELS OUT OF IT LIKE 4-10 PER YEAR TO LIVE ON. THE ONLY WAY THE IRS WOULD KNOW SOMEBODY WAS USING THERE IRA FOR INCOME GENERATING PURPOSES WOULD BE BY SEEING THE WITHDRAWELS. all the irs gets every year is a total account value from your broker not how many trades one made.. also if you trade in other accounts for your incom,e there would never be a problem no matter how much you traded your ira.
this discusioion is getting way far out of hand. i had a friend who daytraded his 200k ira for a living back in 1997 before the days of not being able to daytrade ira's. one msut remeber you're hit hard with the 10% penalty and paying full taxation for taking out withdrawels. also you can't write loses off? he ended up losing 1/2 his ira in 18 months. I'D SAY WITHOUT HESITATION IF THE IRS EVER EVVEN LOOKED AT THIS IT WOULD BE FROM SOMEONE SOLEY TRADING THERE IRA AND TAKING SYSTEMATIC WITHDRAWELS OUT OF IT LIKE 4-10 PER YEAR TO LIVE ON. THE ONLY WAY THE IRS WOULD KNOW SOMEBODY WAS USING THERE IRA FOR INCOME GENERATING PURPOSES WOULD BE BY SEEING THE WITHDRAWELS. all the irs gets every year is a total account value from your broker not how many trades one made.. also if you trade in other accounts for your incom,e there would never be a problem no matter how much you traded your ira.
What you say makes complete sense to me. So I am perplexed why have we got TraderStatus on here (a specialist CPA on trader taxes) flagging this issue? And why is Greentrader, another trader tax specialist, flagging this issue on one of their web pages? That is what concerns me! Failing a clear answer from either of these specialists, I am speculating that it might have something to do with declaring trader status outside the IRA. It's bizarre how these specialists can't/won't explain their concerns ...
it reminds me of when i first used green to do my taxes in 1999. all were scaring me i'd be audited for doing 1 billion in sales and having a 1600 page 1099. enver a problem. i've asked green about the ira issuer years ago. he him hawed around. mjsut like what defines a full time trader? greens told me at least 3 trades a day and it has to be a very substantial portion of your income and you can't have another job. many others will say you can have a job. millions of people day trade there ira. now i suppose if you daytraded it full time and took withdrawels every month they could challange it. what about the guy who works at ibm and trades his ira 15 times a week at work on the net. to say they could disallow him is insane. the irs would open up a can of worms. also as i said oustise taking many withdrawels how could the irs ever keep tabs on how manby times people trade there account. i have an ib roth and trade it at least 5-10 times a week with options and futures. didn't ib jsut change there ira so now you can day trade it and ahve instant access to the funds with no 3 day wait? that sure don';t sound like one can't daytrade it. remember accounatns like fear and chaos as it brings them businmess
remember accounatns like fear and chaos as it brings them businmess
This is exactly what I'm beginning to think this is all about. The trader tax specialists are the ones saying that daytrading your IRA might be a problem - nobody else. Yet none of them have indicated any case precedent to back up their concerns. Seems to me that their concern stems not so much as from potential IRS issues, as it does their own needs to scare people away from IRA trading. These specialists help people reduce tax via trader status, entities etc. But such help can't come close to the Roth IRA which totally eliminates tax altogether.
If IRAs can be daytraded tax-free (Roth) or tax-deferred (Traditional), then people will gravitate towards primarily trading their IRAs for retirement. In which case who needs to bother with setting up businesses with a company pension plan, solo 401k plan etc.? i.e all the stuff they make money pitching. If the IRA can be daytraded tax-free without any problem, demand for these other products might fall.
Maybe that's what this scare-mongering is really all about ....?
