The answer may be “yes” and you may not realize it. If so, your self-directed retirement plan may be responsible for taxes you hadn’t considered. You may think a tax-advantaged account would be exempt from additional charges, but in truth, tax benefits inherent to your IRA or 401(k) apply to contributed funds and distributions down the road. Unrelated business income tax (UBIT) satisfies tax obligations for income earned by particular investment entities.
As people seek new ways to invest for retirement, alternative assets continue to rise in popularity. As such, you’ll need to know whether or not your desired investment vehicle will accrue additional taxes. If your individual retirement plan owes UBIT, your IRA or 401(k) must file a Form 990-T and pay the applicable taxes. UBIT may seem like a burden, but remember that it only applies to earnings. The added expense can be an indicator of your strong retirement strategy, and the subsequent tax filing can be easier than you think.
IRA or 401(k)-held real estate that’s leveraged through non-recourse financing will typically involve the additional taxes, though earnings yielded through operating income are more commonly involved in UBIT considerations. Operating income that qualifies as unrelated business taxable income (UBTI) could include rental income from non-real estate assets (regardless of debt leverage, provided they’re owned directly by the plan) or earnings yielded by a pass-through entity. If your plan is invested in a business that’s owned by a pass-through entity, taxes will not be paid at the corporate level. So, as the name implies, tax liability is passed from the business to its investors, which may include your retirement plan.
Self-directed retirement provides opportunities to limit UBIT-related confusion when integrating common business structures into your portfolio. Partners or managers are typically more involved with these entities, provided they operate within IRS guidelines regarding disqualified persons and self-dealing. A more hands-on approach can provide a higher degree of transparency, so the tax status of earned income should be clear.
Other eligible entities may not incorporate as much investor activity:
Any of these entities could be established through pass-through businesses, and all may be held in self-directed retirement accounts (depending on the policies of certain IRA providers). A Form 990-T is similar to a Form 1040 in that it reports income and helps identify any due taxes, but these business models can be more complicated and professional assistance may be required. Our sister company, IRA Tax Services, specializes in complex tax filings and would be happy to assist you in filing a Form 990-T. For general questions about UBIT or self-directed investing, please don’t hesitate to contact New Direction IRA.