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A qualified plan that is a partner or limited partner is potentially subject to UBTI since there is an "unrelated trade or business" if the qualified plan is a partner (IRC Section 513(b)(2)). I believe the same would apply in the case of the plan that is a member of an LLC which is taxed as a partnership.

1) Does the same rule apply to IRAs? Specifically, is it an unrelated trade or business if an IRA is a partner, or a limited partner, or, in my case, a member of an LLC taxed as a partnership? (I think the answer is No, but that doesn't make a lot of sense to me.)

2) Related issue . . . The IRA uses cash to become a partner by investing in a partnership, or to become a member by purchasing a membership interest in an LLC. If that cash is then used by the parthnership/LLC as security for a loan, does that cause the IRA (or a portion of it) somehow to lose its status as an IRA (under IRC Section 408(e)(4))? (I think the answer is No.)

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A qualified plan that is a partner or limited partner is potentially subject to UBTI since there is an "unrelated trade or business" if the qualified plan is a partner (IRC Section 513(b)(2)). I believe the same would apply in the case of the plan that is a member of an LLC which is taxed as a partnership.

1) Does the same rule apply to IRAs? Specifically, is it an unrelated trade or business if an IRA is a partner, or a limited partner, or, in my case, a member of an LLC taxed as a partnership? (I think the answer is No, but that doesn't make a lot of sense to me.)

I think the answer is Yes, but am intrigued by why you might think otherwise.

2) Related issue . . . The IRA uses cash to become a partner by investing in a partnership, or to become a member by purchasing a membership interest in an LLC. If that cash is then used by the parthnership/LLC as security for a loan, does that cause the IRA (or a portion of it) somehow to lose its status as an IRA (under IRC Section 408(e)(4))? (I think the answer is No.)

I think the answer to this is No. Unlike the penalty for an IRA participating in a prohibited transaction (where the penalty is disqualifying the entire IRA), for UBTI it is the income taxation now and without creating any basis or avoidance of later income taxation.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Q1: Why doesn't 408(e)(1) answer your question?

Q2: How does borrowing by the p/s or llc (or, for that matter, direct borrowing by the IRA) fit within the activity prohibited by 408(e)(4)?

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John & jpod -- Q1: I think IRC Section 408(e)(1)'s last sentence simply causes an IRA to be subject to the same UBTI rules that a qualified plan is, since IRC Secton 511(a) does not include an IRA within its terms--thus the need for 408(e)(1). But, IRC Section 513(b)(2) specifically provides that being a partner automatically, without further investigation or determination, causes a qualified plan to be considered to be carrying on an unrelated trade or business, but there is no comparable language for an IRA to be similiarly treated. Nevertheless, PLR 9703026 says--inexplicably to my mind, unless I'm missing something big here--that "Section 513(b) . . . defines "unrelated trade or business" to mean in the case of an IRA subject to Section 511, any trade or business regularly carried on by such IRA or by a partnership of which it is a member." Does that mean that an IRA is somehow included within Section 513(b)(1)? If so, then I would agree that an IRA as a partner--and presumably as a member of an LLC taxed as a partnership--would be subject to UBTI; if not, that seems to mean that an IRA which is a limited partner may not be carrying on a trade or business.

jpod -- Q2: I don't believe that the LLC using the IRA assets as security for a loan would be treated as a PT as to the IRA (within the parameters of IRC Section 408(e)(4)), but I was just wondering out loud if I might have missed something. I presume you think not.

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My bad for not focusing on your reference to 513(b)(2). I agree that 513(b)(2) by its literal terms does not sweep in IRAs. Is the plr you cited one of a kind (so as to be a mistake)? What do pertinent IRS publications say, or the instructions to the 990-T or 1065?

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Can't find any updates on the position in the PLR I cited. Thanks, though, for suggesting looking at the 990-T, because it is specifically mentions there that an IRA must file a return if it has UBTI (as I would have expected) . Can't find any other references. The question, I guess, is whether the LLC interest is an automatic UBTI determining factor for the IRA.

Thanks for your help.

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John & jpod -- Q1: I think IRC Section 408(e)(1)'s last sentence simply causes an IRA to be subject to the same UBTI rules that a qualified plan is, since IRC Secton 511(a) does not include an IRA within its terms--thus the need for 408(e)(1). But, IRC Section 513(b)(2) specifically provides that being a partner automatically, without further investigation or determination, causes a qualified plan to be considered to be carrying on an unrelated trade or business, but there is no comparable language for an IRA to be similiarly treated. Nevertheless, PLR 9703026 says--inexplicably to my mind, unless I'm missing something big here--that "Section 513(b) . . . defines "unrelated trade or business" to mean in the case of an IRA subject to Section 511, any trade or business regularly carried on by such IRA or by a partnership of which it is a member." Does that mean that an IRA is somehow included within Section 513(b)(1)? If so, then I would agree that an IRA as a partner--and presumably as a member of an LLC taxed as a partnership--would be subject to UBTI; if not, that seems to mean that an IRA which is a limited partner may not be carrying on a trade or business.

I think that being subjected to Section 511 (due to the last sentence of Section 408(e)(1)), an IRA is treated like a QRP for purposes of Sections 511-514. The reason is that those Sections 511-514 were not drafted with IRAs in mind. So there was no reason to specify it in Section 513(b)(1). I think the IRS got it right in PLR 9703026 by an interpretation that essentially adds IRAs to the types of trusts listed in Section 513(b)(1).

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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JSimmons: Huh? The only thing 408(e)(1) does pertinent to UBTI is to make IRAs subject to the taxes imposed by 511 (because if it didn't, there is nothing in 511 itself that would make an IRA subject to UBTI taxes). 408(e)(1) does not say anything like "an IRA shall be treated as a 401(a) plan for purposes of 511." So, how does 408(e)(1) make 513(b) applicable to IRAs?

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JSimmons: Huh? The only thing 408(e)(1) does pertinent to UBTI is to make IRAs subject to the taxes imposed by 511 (because if it didn't, there is nothing in 511 itself that would make an IRA subject to UBTI taxes). 408(e)(1) does not say anything like "an IRA shall be treated as a 401(a) plan for purposes of 511." So, how does 408(e)(1) make 513(b) applicable to IRAs?

And all Sections 512-514 do is define what is and is not UBTI for purposes of being taxed under Section 511. Is your position that IRAs are subject to tax on UBTI but there is no definition of UBTI as taxable to IRAs?

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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JSimmons: I'm not following you. All I am saying is that the special partnership attribution rule in 513 does not appear to apply to IRAs.

Why?

IRC 408(e)(1) incorporates the applicability of the UBIT tax of IRC 511 on tax exempt organizations to IRAs. IRC 511 in turn imposes the UBIT tax on unrelated business taxable income as defined in IRC 512. 512 in turn defines UBTI as gross income of the organization as defined in 513 less deductions.

By deductive reasoning the application of IRC 511 to IRAs by IRC 408(e)(1) includes the provisions of IRC 513 as noted the the PLR. Also Pub 598 P1 notes that IRAs are subject to UBIT rules as are qualified plans. P13 provides the rules for UBIT to partnership interests of TXOs without mentioning an exception for IRAs.

mjb

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mbozek: But, as Sieve pointed out, the special partnership attribution rule of 513(b) by its terms applies only to certain entities which would not include IRAs. I am not seeing the linkage of 513(b) to IRAs.

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My understanding is that being a limited partner does not necessarily cause a tax-exempt or non-profit to be considered to be carrying on an unrelated trade or business--and, in fact, a limited partner generally is not considered to reach that threshold. But, IRC Section 513(b) does cause a limited partner to be subject to UBTI (whether or not it otherwise would rise to the level of carrying on an unrelated trade or business).

mbozek -- Without the PLR, I, like jpod, do not see the connection between being subject to IRC Section 511 and being swept up into the specific circumstances of IRC Section 513(b). For example, a non-profit is not swept up into Section 513(b)--even though it is subject to Section 511 like an IRA is--so how does the outside reference subjecting IRAs to IRC Section 511 somehow turn into IRAs also being subjected to the rule of IRC Section 513(b) (which, by the way, is not the rule for all entities subject to Section 511)? Section 513(b) doesn't apply to all trusts, or else it would say so--it applies only to those trusts delineated, and IRAs are not included. I think that the PLR overextends the IRS's interpretative powers. If IRAs, subject to IRC Section 511, are included in Section 513(b)(2) by incorporation, then why aren't they also incorporated into the exception to acquisition indebtedness UBTI contained in IRC Section 514©(9) (which applies, by definition, only to qualified plans through IRC Section 514©(9)©)?

That being said, it really makes no sense to me, on a practical level, that an IRA would be treated differently, with respect to ownership of a partnership interest, than would a qualified plan--although that certainly would not be the first time that an IRA would be treated differently from a qualified plan (see above).

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513(a) specifies, for UBTI purposes, that with limited, incidental exceptions an 'unrelated trade or business' is "any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption" under Section 501.

Since the basis of the tax exemption of a QRP (401a plan the trust of which is exempt from tax under 501a) is to save and invest for retirement, there is no trade or business that is substantially related to its purposes. That's what the effect of 513(b)(2) is.

Since an IRA, like a QRP, is for retirement savings and investments, there is no trade or business that the IRA may regularly carry on or be a partner of that is 'substantially related' to its purpose.

That's why I say the IRS got it right in PLR 9703026 when it lumped IRAs in with QRPs for purposes of UBTI if the IRA regularly carries on a trade or business, or is a partner in a venture that does so.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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OK. Assume that the IRS position in the PLR is correct (that's a concept!), whether I agree with it or not. How do you think a membership interest in an LLC (taxed as a partnership) will fall? As a shareholder (no UBTI), or as a partner (UBTI)? And, should its method of taxation be a determining factor (i.e., should an LLC membership of the IRA be treated differently depending on the LLC's tax status)?

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As a partner (UBTI).

Generally speaking, an LLC that chooses to be taxed as a partnership is treated as such under the Code. An LLC that chooses to be taxed as a corporation bears most of the indicia of a corporation, except most notably internal governance. Also, given that an S corporation is taxed similarly to a partnership--current, pass-thru--investment in the S corporation can generate UBTI.

So I do think the taxing status chosen by the LLC is determinative.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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OK. Assume that the IRS position in the PLR is correct (that's a concept!), whether I agree with it or not. How do you think a membership interest in an LLC (taxed as a partnership) will fall? As a shareholder (no UBTI), or as a partner (UBTI)? And, should its method of taxation be a determining factor (i.e., should an LLC membership of the IRA be treated differently depending on the LLC's tax status)?

Given that the statutory language for imposing UBTI on IRAs was intended to apply the rules for qualified plans and since IRAs do not conduct a trade or business anymore than a qualified plan why would an IRA's partnership interest be exempt from tax under 513?

The election of an LLC to be taxed as a partnership results in the interest being subject to UBTI since the election applies for all purposes.The larger question is whether the taxpayer must dislcose the LLP interest and file a tax return to avoid tax penalities.

mjb

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I am still not seeing the linkage. JSimmons (and maybe mbozek too) seems to be saying that Congress should have amended 513(b) to include IRAs, and because it did not do that IRS can apply 513(b) to IRAs administratively. I disagree.

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I do not think IRS should 'write' into tax law what Congress did not.

Section 513 defines unrelated trade or business that generate UBTI. For any given 501c3 charity, there are trace or business activities that are related to its tax-free purposes and those that are not. Suppose that is the prevention of cruelty to animals in a given case. Operating a hamburger joint is obviously unrelated, and would cause UBTI. Operating a humane kennel on the other hand is related, and profits from it should not be subject to UBTI.

The tax-free purpose of a 401a QRP is retirement savings. Arguably, any business could be related to that purpose. After all, business profits like investment returns add to the accumulation of retirement savings. Ergo, all active businesses would be 'related' to the tax-free purpose of a 401a QRP.

It is also arguable that no active business is related to it, but rather there should be UBTI from anything but passive investments. Section 513b2 makes clear the public policy chosen by Congression that any business activity that is regularly carried on is unrelated to the tax-free purpose of a 401a QRP for retirement savings.

It is not, in my opinion, and I do not want to give the impression that jpod has apparently taken from my prior posts in this thread, that the role for the IRS is to write into statutes what Congress did not. jpod is correct that Congress did not legislate that all active businesses are unrelated to the tax-free purpose of IRAs. But it is equally true that Congress did not legislate that all active businesses are related to the tax-free purpose of IRAs. Congress has has not addressed that.

But Congress did legislate that IRAs should be subject to UBTI (section 408(e)(1)). A proper role then for the IRS is to give interpretive guidance on how UBTI rules should apply to IRAs. Since the tax-free purpose of an IRA is the same as that of a 401a QRP, the IRS weighed in that Congress' express policy that any active business causes UBTI where the tax-free purpose is retirement savings is the closest, most analogous to IRAs.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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JSimmons: I agree with everything you said. But you did not explain why/how 513(b) applies to IRAs. That is all this thread is about.

I appreciate that you do not think that I have, but I'll leave that for each reader to determine for him or her self whether I (with mbozek's able assistance) have explained why and how the IRS determined in PLR 9703026 that 513(b) applies to IRAs.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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JSimmons: Here is what 513(b) says:

(b) Special rule for trusts

The term ``unrelated trade or business'' means, in the case of--

(1) a trust computing its unrelated business taxable income

under section 512 for purposes of section 681; or

(2) a trust described in section 401(a), or section 501©(17),

which is exempt from tax under section 501(a);

any trade or business regularly carried on by such trust or by a

partnership of which it is a member.

Here is what the IRS said in the private ruling:

Section 513(b) of the Code defines “unrelated trade or business” to mean in the case of an IRA subject to section 511, any trade or business regularly carried on by such IRA or by a partnership of which it is a member.

The IRS did not explain how it came to that conclusion (because there is no explanation, it was a mistake).

We'll just have to agree to disagree.

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This is an interesting issue and the thread has been good to follow. I searched the internet and found a plethora of articles that agreed with JSimmons and mbozek. However I did find the following on Self Directed IRA website

UBIT in an IRA

There is a commonly repeated view on Internet discussion groups, that "If your IRA invests in things that produce Unrelated Business Income (UBI), and the net income from these investments exceeds $1,000, your IRA could be subject to the Unrelated Business Income Tax (UBIT)". This is possibly a myth. The 2006 Tax Information packet for Hugoton Royalty Trust states, in page 9, "In the opinion of the trust's tax counsel, Winstead Sechrest & Minick P.C., the income of the trust will not be unrelated business taxable income so long as the trust units are not 'debt-financed property' within the meaning of section 514(b). In general, a trust unit would be debt-financed if the trust unitholder incurs debt to acquire a trust unit [...]".

However, the IRS does unequivocally state in the first few paragraphs of Chapter 1 of the November 2007 revision of Publication 598 that IRAs are "subject to the tax on unrelated business income.

So, at the very least, someone agrees with jpod. And if the report is correct, the law firm named is willing to give a tax opinion on the subject. My guess is that they will either hedge if contacted, or will quote an exorbitant price (north of $50,000) for such an opinion.

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Thanks, vebaguru.

That quote from the Self Directed IRA Website is an exact quote of the first two of three paragraphs on Wikipedia. The third paragraph reads:

The side of the "debate" which contends that there is no tax on UBI in an IRA account seems on its face contrary to the provisions of the Internal Revenue Code. 26 U.S.C. §408 creates the individual retirement accounts and 408(e)(1) states: "Any individual retirement account is exempt from taxation under this subtitle unless such account has ceased to be an individual retirementaccount by reason of paragraph (2) or (3). Notwithstanding the preceding sentence, any such account is subject to the taxes imposed by section 511(relating to imposition of tax on unrelated business income of charitable, etc. organizations)."

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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To all: This is my last post on this subject. We are not talking about whether an IRA will be taxed on UBTI; it most certainly will. We are talking about whether the rule of 513(b) attributing a trade or business of a partnership in which an entity invests applies to an IRA that invests in a partnership. By its terms 513(b) does not apply to IRAs, and the 97 letter ruling is wrong.

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