Registered: Feb 2004
09-28-05 01:23 AM
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:
$0 - $2,000 = 15%
$2,000 - $4,700 = 25%
$4,700 - $7,150 = 28%
$7,150 - $9,750 = 33%
Over $9,759 = 35%
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.