UBTI on IRAs

[Guest Pat Metallic]

Our research indicates that qualified retirement plans which use leverage to buy real estate are exempt from the UBTI tax. On the other hand, IRAs that use this same investment strategy are NOT exempt from the UBTI on the related rental income. Is there an explanation as to why these types of plans are treated differently?

[No Name]

Just guessing. Borrowing is allowed in qualified plans, but not in IRAs. Using leverage is borrowing.

[Belgarath]

I wouldn't make a blanket statement that plans which use leverage to buy real estate are exempt from UBTI. There are several restrictions - see IRC 514©(9)(B).

As to why the difference between this and IRA's, sorry, I haven't a clue.

[Kirk Maldonado]

It's been a while since I worked on this issue, but I seem to recall that the exemption for UBTI relating to leveraged purchases of real estate provided by section 514©(9) is limited to qualified plans, so that it does not apply to IRAs.

[JAY21]

Pat, since you're hot on the research trail on these issues, what did you conclude about leveraged real estate where there will also be rental income derived from the property ? still exempt from UBTI if structured properly ? That's always the one I hesitate the most about although I still think it works if the restrictions and proper structure of the loan conditions are met.

[Kirk Maldonado]

JAY21 brings up a good point, that I intentionally glossed over before, to avoid inundating people in detail.

Analytically, it is easiest to think of there being two components of UBTI. UBTI proper and unrelated debt-financed income ("UDFI"). In general, you trigger UBTI if the plan is directly or indirectly carrying on a trade or businesst. You can trigger UDFI if you purchase the investment with borrowed funds, even if the income that you would otherwise not be UBTI.

But I want to add the caveat that it has been a number of years since I did much UBTI or UDFI work, so the law may have changed or my memory may be faulty. If anybody spots any errors in this brief synopsis of the rules, please chime in.