One of the questions we receive a lot is, “Does a Self-Directed IRA file a tax return?” In most case, there are no tax filing requirements for your IRA. However, that does not mean you are completely off the hook when it comes to your IRA and its investments. Depending on your investments, you may be subject to the UBTI tax. For example, you borrow funds to buy real estate with your IRA. If you do not owe UBTI, you will likely fill out a simple valuation form as explained in the following.
- Most IRAs are not subject to tax on an annual basis
- Generally, you must file a valuation form for your Self-Directed IRA
- Some investments, such as real estate, may owe UBTI tax, in which case, Form 990-T must be filed
- Any taxes that are due must be paid from your IRA
What tax forms do I need to file for my Self-Directed IRA LLC?
Let’s step back to understand some basic concepts:
First, it’s important that you know that your LLC (Limited Liability Company) is owned by your IRA (Individual Retirement Account).
Second, IRAs are not subject to federal taxes. Also, the way your IRA withdrawals are taxed depends on the type of IRA you open. Is it a traditional retirement account? Is it a Self-Directed Roth? If it’s a traditional retirement account, contributions are taxed during withdrawals. Ideally, the withdrawal is made when you are age 59 1/2 or older. If you make a withdrawal prior to that age, and it isn’t permitted, you will receive a 10% early withdrawal penalty. If you have a Roth IRA, you pay taxes upfront. As a result, your earnings are tax-free.
Third, there is a difference between a single-member LLC and a multi-member LLC.
Multi-Member LLC vs Single Member LLC
A single-member LLC is a Limited Liability Company holding one set of IRA funds. In other words, the LLC only contains funds from one IRA. A single-member LLC can have a co-manager, as long as the co-manager is not contributing IRA funds into the LLC.
A multi-member LLC is defined as a Limited Liability Company that has:
- More than one person (e.g., a husband and a wife) contributing IRA funds to the LLC
- More than one type of IRA funds in the LLC
For example, if one person contributes to a Traditional retirement account and a Roth IRA, then this is considered as a multi-member LLC.
UBTI and UDFI
There are two specific tax requirements when investing with a Self-Directed IRA.
Unrelated Business Taxable Income, or UBTI, is defined as “gross income derived by any organization from any unrelated trade or business regularly carried on by it.” Basically, if your IRA owns a business, such as a restaurant, you will be subject to UBTI.
When it comes to real estate investing, you may or may not be subject to UBTI. Rental income from real property is considered passive income and is not subject to UBTI. However, if you buy and sell many real estate properties throughout the year, this may be considered an active business and you will owe taxes.
Speaking of real estate, Unrelated Debt-Financed Income, or UDFI, is another type of UBTI. If you use a loan to acquire a property with your Self-Directed IRA, the income generated by the property is taxed. For example, you use a non-recourse loan to purchase 50% of a property, then half of the income generated from it will be subject to taxes.
If you owe UBTI and/or UDFI taxes, you will need to file the appropriate forms with the IRS. See Below.
What About Filing Tax Returns?
No UBTI or UDFI Taxes
You don’t need to file any tax forms with the IRS (Internal Revenue Service) if your LLC is a single-member LLC.
The IRS requires an annual valuation of the LLC and its assets. Your passive custodian will send you the valuation form (Form 5498) to complete and will file it with the IRS on your behalf. This is how the IRS keeps record of your IRA LLC, its value and holdings.
With a multi-member LLC, you are required to file Form 1065 with the IRS. However, no taxes are due.
You Owe UBTI or UDFI Taxes
Generally, these are the two reasons you would owe taxes on your Self-Directed IRA in a given year. If you do owe, you will need to file IRS Form 990-T. You, as the account holder of the IRA, will need to pay any taxes due annually. It is important to note that taxes must be paid from money held by the IRA.
It’s best to avoid activities that create these taxes since the main advantage of an IRS is its special tax treatment.
Related: Self-Directed IRA LLC Taxes by State
To learn more about the tax requirements for a Self-Directed IRA, please contact a Self-Directed IRA expert at 800-472-0646.