Calculating Tax on UDFI from IRA Investments

Your individual retirement account (IRA) is typically considered to be tax-exempt. However, when your IRA borrows money in a non-recourse loan, the owner must file the Internal Revenue Service (IRS) Form 990-T and a Schedule E. They also must report the income generated by the loan as it may be subject to taxes.

Filling Out the Form

Unrelated Debt Financed Income (UDFI) is generated when an IRA borrows money to purchase real estate. UDFI also requires the account holder to file Form 990-T with the IRS, similarly to UBIT.

You will find eight columns under Section E of IRS Form 990-T. These are as follows:

Column 1.   During the year, if there was an outstanding loan on the property owned by the IRA, that property would be considered debt financed. This is true even if the property is sold at a gain before the end of the taxable year.
Column 2.   Income cannot be taxed twice. If your IRA generated an income via a business investment through the use of a limited liability company (LLC), this income cannot be taxed again.
Column 3.   These are your deductions.
Column 4.   The average acquisition indebtedness can be tricky to calculate. Start with figuring out which months your IRA owned the property during the year. Once you do this, figure out the outstanding principal debt on the first of each of those months. Add them together then divide that sum by the number of months.
Column 5.   Section 1011 of the IRS Code can help to explain how to find the adjusted basis for the debt financed property owned by your IRA. Once you determine this value, you would need to adjust it for the depreciation of the previous tax years.
Column 6.   To find the value of column 6, simply divide column 4 by column 5.
Column 7.   Calculating the amount of income generated by your debt-financed property can be confusing. First, divide the property’s average acquisition indebtedness for the tax year by the property’s average adjusted basis. Once you have this number, multiply it by the property’s gross income. (This percentage cannot exceed 100%.)
Column 8.   Sum up your total deductions from column 3. Multiply this by your response to column 6.

Unrelated Business Taxable Income (UBTI) Tax Rate

Your self-directed IRA (SDIRA) is subject to the IRS UBTI tax rates. Why? Because the IRS treats your SDIRA as a trust. For 2020, these rates are:

  • Up to $2,600: 10% of the amount over zero
  • $2,600 up to $9,450: $260 + 24% of the amount over $2,600
  • $9,450 up to $12,950: $1,904 + 35% of the amount over $9,450
  • $12,950 and over: $3,129 + 37% of the amount over $12,950

We Can Help

When you have an account with Royal Legal Solutions, you can rest assured that your IRS forms are filed correctly. Not only do we help you understand the regulations and requirements of the IRS, but we will handle the paperwork for you. After all, these forms can be tricky and sometimes complicated. Let us help. Contact the professionals at Royal Legal Solutions today to find out more about what we can do to make your IRA ownership easier.

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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