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What is the UBTI tax rate?

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UBTI (Unrelated Business Taxable Income) tax is defined as “gross income derived by an organization from any unrelated trade or business regularly carried on by it.” It is not a well-known tax because it generally only applies to tax-exempt organizations. UBTI tax serves as a dual purpose. First, it prevents tax exempt businesses, such as a non-profit, from competing unfairly with taxable organizations. It also prevents tax-exempt business from engaging in a business unrelated to its primary business objectives.

There are a number of organizations considered tax-exempt under IRC section 501, but if the tax-exempt organization engages in an activity that has no relation to its business (and generates income from that activity), it may be subject to the UBTI tax.

UBTI Tax and IRAs

An IRA has many tax advantages, such as the ability to generate tax-free gains until you take a distribution. Generally, if you make an investment with an individual retirement account, it will not be subject to the Unrelated Business Taxable Income tax if it generates passive income. Some forms of passive income include:

  • Interest from loans
  • Dividends
  • Annuities
  • Royalties
  • Most rentals from real estate
  • Gains/losses from the sale of a capital asset, such as real estate

If you use a Self-Directed IRA that does trigger the Unrelated Business Taxable Income tax, it will be taxed at a trust tax rate because an IRA is considered a trust. The 2019 tax rates are as follows:

  • $0 – $2,550 = 10% of taxable income
  • $2,551 – $9,150 = $255 + 24% of the amount over $2,550
  • $9,151 – $12,500 = $1,839 + 35% of the amount over $9,150
  • $12,501 + = $3,011.50 + 37% of the amount over $12,500

How Investors Trigger Unrelated Business Taxable Income with IRA

There are certain instances where your IRA can trigger this tax. If the IRA investment is regularly carried on, it will trigger UBIT. Examples include:

  • Margin to buy stock
  • Nonrecourse loan to buy real estate (401k is excluded from this)
  • Investment in an active trade or business

The most common types of investments that can potentially trigger UBIT are:

  • Passthrough business investments
  • Investing in a venture capital fund that invests in passthrough businesses
  • Private equity fund investments that invests in passthrough businesses
  • Hedge fund investments that use debt
  • Real estate fund investments that use debt
  • Purchasing real estate with an IRA and using a nonrecourse loan
  • Using a loan to purchase stocks or other passive investments

2019 UBIT Changes

There were no changes to the UBTI tax in 2019. However, it’s important for retirement account investors who want to purchase alternative asset investments to be aware of the UBTI tax rules.

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