In IRS Notice 2020-23, the IRS announced that all personal and entity tax return filing deadlines for the 2019 taxable year have been extended to July 15, 2020. This includes the filing of the return and any tax payments due. In addition, IRS Notice 2020-23 extended the tax filing deadline for IRS Form 990-T for any Self-Directed IRA or 401(k) plan that generated over $1,000 of unrelated business taxable income (UBTI) in 2019.
When Do You Need to File a 990-T?
In general, only income generated from an active trade or business (i.e. a restaurant) via a pass-through entity (such as an LLC), margin, or real estate acquisition indebtedness would be subject to the UBTI tax. However, in the case of a Solo 401(k) plan, there is an exemption under IRC 514(c)(9) for any plan that generated income from a real estate investment involving a nonrecourse loan (real estate acquisition indebtedness). Note, most self-directed retirement investments would not trigger the UBTI tax. For example, any transaction that does not involve debt and generates capital gains, interest, dividends, rental income, and royalty income would not trigger the UBTI tax and the requirement to file IRS Form 990-T.
Once you have determined that the UBTI tax rules will apply to a Self-Directed IRA or Solo 401(k) plan investment, the next part is figuring out how much tax will be due. If an IRA or 401(k) plan generates gross income subject to UBTI of more than $1,000 during the taxable year, the retirement account must file IRS Form 990-T. Form 990-T is the tax form where a charitable organization or retirement account, such as an IRA or Solo 401(k), reports income that would be subject to the UBTI tax.
The most common type of investment that triggers UBTI, is real estate. As we mentioned above, there is an exception with 401(k) plans. When investing in real estate using a Solo 401(k) plan, the UBTI tax is not in effect. However, when investing in real estate with an IRA, you must be aware of the rules. A traditional loan is not allowed with an IRA since it will violate the prohibited transaction rules. Therefore, only a nonrecourse loan is allowed.
If you need to borrow money to make a real estate investment with your Self-Directed IRA, you will be subject to UBTI. The current tax rate sits at a whopping 37%. The bigger the loan, the more taxes will be owed. It’s important to minimize the amount you borrow for a real estate investment. Borrowing too much may make your investment not as tax-advantageous as it should be.
C Corp Blocker Approach
One other way to limit your tax exposure is the C Corporation Blocker strategy. As an investor, you can create a C Corp that your Self-Directed IRA will own. Your real estate investment will be made by the C Corp. Because it is treated as an entity for tax purposes, the UBTI tax will not be triggered. However, it will be taxed at corporate tax rates. The good news is that the tax rate is only 21%, far less than the 37% UBTI tax rate.
990-T Deadline Extended
Under IRS Notice 2020-23, the new deadline for filing IRS Form 990-T any paying any tax due is July 15, 2020. It is important to note that the IRS Form 990 is not part of your personal income tax return and is only being filed because a retirement account has generated UBTI. The UBTI tax is typically paid by the retirement account. In general, the IRS Form 990-T is completed like a corporate return and includes reporting all income and expenses related to the Self-Directed IRA or Solo 401(k) plan investments.