IRS Form 990-T, specifically Schedule E, is the tax form where a charitable organization of retirement account, such as an IRA or Roth IRA would report income that would be subject to the Unrelated Business Taxable Income (also known as UBIT or UBTI) or Unrelated Debt Financed Income tax. In general, only income generated from an active trade or business via a passthrough entity, margin, or real estate acquisition indebtedness would be subject to the UBTI/UBIT tax.
In general, when debt-financed property is held for exempt purposes and other business purposes, the organization must allocate the basis, debt, income, and deductions among the purposes for which the property is held. One would not include in Schedule E amounts allocated to exempt purposes
What is Acquisition Indebtedness?
Any property held to produce income is debt-financed property if at any time during the tax year there was acquisition indebtedness outstanding for the property.
When any property held for the production of income by an organization is disposed of at a gain during the tax year, and there was acquisition indebtedness outstanding for that property at any time during the 12-month period before the date of disposition, the property is debt-financed property. Securities purchased on margin are considered debt-financed property if the liability incurred in purchasing them remains outstanding. Note – a 401(k) Plan is exempt from tax on income attributable to acquisition indebtedness. Thus, no UBTI or UDFI tax would apply in the case of a Solo 401(k) Plan that used a non-recourse loan to purchase real estate. The tax would, however, apply if margin was used, which is not treated as acquisition indebtedness.
Acquisition indebtedness is the outstanding amount of principal debt incurred by the organization to acquire or improve the property:
- Before the property was acquired or improved, if the debt was incurred because of the acquisition or improvement of the property; or
- After the property was acquired or improved, if the debt was incurred because of the acquisition or improvement, and the organization could reasonably foresee the need to incur the debt at the time the property was acquired or improved
Average acquisition indebtedness for any tax year is the average amount of the outstanding principal debt during the part of the tax year the property is held by the organization. To figure the average amount of acquisition debt, determine the amount of the outstanding principal debt on the first day of each calendar month during that part of the tax year that the organization holds the property. Add these amounts together, and divide the result by the total number of months during the tax year that the organization held the property.
The average adjusted basis for debt-financed property is the average of the adjusted basis of the property on the first and last days during the tax year that the organization holds the property. Adjust the basis of the property by the depreciation for all earlier tax years, whether or not the organization was exempt from tax for any of these years. Similarly, for tax years during which the organization is subject to tax on unrelated business taxable income, adjust the basis of the property by the entire amount of allowable depreciation, even though only a part of the deduction for depreciation is taken into account in figuring unrelated business taxable income.
The amount of income from debt-financed property included in unrelated trade or business income is figured by multiplying the property’s gross income by the percentage obtained from dividing the property’s average acquisition indebtedness for the tax year by the property’s average adjusted basis during the period it is held in the tax year. This percentage cannot be more than 100%.
The following is an example offers some insight as to how one would go about calculating the amount of income that would be reportable on the IRS Form 990-T and be subject to the UBIT tax.
An individual used a self-directed IRA LLC to purchase a home for $100,000. The IRA holder invested $50,000 of IRA funds and acquired a non-recourse loan for the remaining $50,000 of the purchase price. The home is rented to a tenant who pays $10,000 a year in rent. Expenses are $1,000 for depreciation and $5,000 for other expenses that relate to the home. The average acquisition indebtedness is $50,000, and the average adjusted basis is $100,000. Both apply to the home.
To complete Schedule E for this example, describe the property in column 1. Enter $10,000 in column 2 (gross income allocated to deb financed property), $1000 and $5000 in columns 3(a) and 3(b) (expenses allocated to debt financed property), respectively and $50,000 and $100,000 in columns 4 and 5 (amount of average acquisition debt and average adjusted basis of debt financed property), respectively, 50% in column 6 (sum of column 4 divided by the sum from column 5), $5,000 in column 7 (the sum of column 2 multiplied by the sum of column 6), and $3000 in column 8 (sum of column 6 – 50% multiplied by the sums from columns 3(a) and 3(b) $6,000). Then subtract the amount in Column 7 ($5,000) from the amount in column 8 ($3,000) to determine the unrelated debt fined income amount – $2,000 based off the above example.