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Unrelated Business Income Tax and Unrelated Debt Financed Income

Certain active (as opposed to passive) investments by your IRA could produce income that might be subject to Unrelated Business Income Tax (UBIT), if the income (less allowable deductions) from the investment exceeds $1,000 in a tax year.

Congress created UBIT to “even the playing field” between tax-exempt entities earning a profit on their investments tax free and for-profit businesses required to pay tax on the same type of investment income.  An IRA, as a tax-exempt trust, may be affected by this tax.

UBIT does not generally apply to passive investments made by an IRA.  However, if the IRA earns money from an active business pursuit, the income from that activity may be subject to UBIT.  In real estate, UBIT may apply if, for example, the IRA was involved in a development project, or a property renovation resulting in resale.  Also, if the property is debt-financed, UBIT may apply.  The determination of whether an investment by your IRA is passive or active should be made by a tax expert.  You should consult with your tax advisor prior to investing your IRA in real estate or another business pursuit.  Capital IRA does not provide investment or tax advice.

The application of UBIT or UDFI to your IRA-owned asset is not necessarily a bar to investment.  The value of your IRA investment should take many factors into account.  Proper structure of your transaction will maximize the tax benefits to your IRA in the future.

IRS Publication 598 describes the tax on unrelated business income of exempt organizations.

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