Understanding Unrelated Business Income Tax (UBIT) and Your Self-Directed IRA

At Beaird Harris, we know that retirement accounts like IRAs can be powerful tools for long-term wealth accumulation. But while IRAs offer attractive tax advantages, certain types of investments can trigger unexpected tax consequences — including something called the Unrelated Business Income Tax (UBIT).

Whether you’re investing through a Traditional, Roth, SEP, or SIMPLE IRA, it’s important to understand when UBIT might apply and how it could impact your account.

What is UBIT?

In most cases, IRAs grow tax-deferred or tax-free — but not always. Under the IRS Code, IRAs must pay tax on income derived from unrelated business taxable income (UBTI). That includes certain types of non-traditional investments that generate income through active business activities or leveraged real estate.

Put simply: if your IRA earns income from a trade or business, it could owe taxes.

When Does UBIT Apply?

Here are some of the most common scenarios where UBIT comes into play:

• Investing in Active Businesses through Partnerships or LLCs
  If your IRA invests in a business operating as a partnership or LLC — like a tire distributor, retail store, or restaurant — the IRA’s share of that business income is typically considered UBTI, may be taxed, and may require a separate tax return.
• Using Debt to Acquire Investment Property (UDFI)
  If your IRA uses borrowed funds to acquire or improve real estate, the portion of income (including rental income or capital gains) tied to the debt-financed part of the property is UBTI and could be subject to UBIT.
• Operating a Business Directly
  If an IRA directly owns and operates a business — say, it runs a food truck or retail shop — all net income from that activity is generally taxable under UBIT rules.

What Income is Not Subject to UBIT?

Fortunately, many traditional investment types are excluded from UBTI, including:

• Interest and dividends
• Royalties
• Most real estate rental income
• Capital gains from property sales (with some exceptions)

However, these exclusions don’t apply to income from debt-financed properties or certain controlled entities, so it’s always worth reviewing your investment structure carefully.

What Are the Tax and Filing Requirements?

If your IRA earns $1,000 or more in UBTI in a year, it’s required to file IRS Form 990-T and pay UBIT. The tax is paid from the IRA’s assets — not out of your own pocket — and is calculated at trust tax rates, which escalate quickly.

Important note: If your IRA has multiple unrelated business investments, the IRS requires income and losses to be tracked separately. Losses from one cannot offset income from another.

Real-World Examples

• Example 1: Your IRA invests in a limited partnership that distributes auto parts. Even if you’re not a material participant investor, your share of the partnership’s income is considered UBTI and subject to UBIT.
• Example 2: Your IRA joins a real estate partnership that uses leverage to buy an apartment complex. The portion of rental income or gains attributable to the borrowed funds is considered UBTI.

Final Thoughts

UBIT isn’t inherently bad — in fact, it can be a reasonable trade-off for pursuing high-return, non-traditional investments. But it’s important to go in with your eyes open. The rules are complex, the tax rates can be steep, and compliance may involve filing a separate tax return.

Before making any non-traditional IRA investments, we recommend a thorough review of the tax implications.

Need Guidance?

Our team is here to help you navigate the complexities of IRA investments and assess whether the potential benefits outweigh the risks. If you have questions or want to explore your options, schedule a conversation with your Beaird Harris advisor today.