Understand how UBIT affects traditional and Roth IRAs, and explore strategies to minimize tax impact on your retirement savings.
Do you own a traditional IRA, Roth IRA, SEP-IRA, or SIMPLE IRA? Usually, the income earned within these accounts is tax-free. This applies to common investments such as stocks, bonds, mutual funds, ETFs, CDs, and Treasury bills.
But if your IRA makes alternative investments, it may be subject to a special tax called the unrelated business income tax (UBIT)—and that’s true even if it’s a Roth IRA.
Beware of UBIT Lurking in Your IRA—It Causes Double Taxes
When Does UBIT Apply?
Investing in active businesses. If your IRA invests in an S corporation, a limited partnership, a regular partnership, or an LLC engaged in an active business, it may owe UBIT.
This does not apply to investments in C corporations because such corporations pay their own taxes
A common example of a UBIT-generating investment is an investment in a master limited partnership.
Using debt financing in a self-directed IRA. If your self-directed IRA buys real estate or other assets using debt, it may owe the UBIT on its unrelated debt-financed income.
For example, if your IRA buys a $500,000 rental property with $250,000 of debt, 50 percent of the rental income is subject to UBIT
How UBIT Works
Tax rates. UBIT is taxed at trust tax rates, reaching the top 37% bracket at just $14,450 of taxable income.
Exemption. Each IRA gets a $1,000 exemption from UBIT annually.
Filing requirements. If an IRA generates more than $1,000 in unrelated business taxable income, it must file Form 990-T electronically and the IRA (not you personally) must pay the tax.
The IRA custodian handles this filing separately. It’s not part of your personal tax return
Double taxation for traditional IRAs. A traditional IRA paying UBIT faces double taxation—first at punitive trust rates and then at ordinary income rates when you, the traditional IRA owner, withdraw funds.
Key Point
IRAs should generally avoid investments that generate UBIT.
Contact your tax and financial advisors to determine the best moves for your situation.