On this episode of Adam Talks, tax attorney and IRA Financial’s founder, Adam Bergman, Esq., discusses unrelated business taxable income, UBIT or UBTI, how the tax may affect your investments, and why it’s not as bad as you might think.
UBIT is not as Bad as You Think for Your IRA
Adam Bergman, a tax attorney and founder of IRA Financial, discusses the implications of the Unrelated Business Income Tax (UBIT) on IRAs in his podcast. He explains that UBIT, a tax imposed on certain sources of income for tax-exempt entities, was initially created to prevent corporations from avoiding taxation by operating businesses through charities. However, these rules also apply to IRAs, which do not have an exempt purpose like charities do.
Bergman outlines the history and rationale behind UBIT, emphasizing how it was designed to target income unrelated to a charity’s main purpose. For charities, unrelated business income includes revenue from activities not related to their primary mission. This rule was established to prevent businesses from exploiting tax-exempt status by operating through charities.
In the context of IRAs, UBIT can be triggered in three main scenarios: using a non-recourse loan to buy real estate, acquiring assets like stocks with a non-recourse loan, and investing in an active trade or business through a pass-through entity such as an LLC. Unlike publicly traded corporations, pass-through entities do not have a corporate-level tax, which can result in UBIT being imposed on the IRA owner.
Bergman acknowledges the high tax rates associated with UBIT, which can go up to 37%, making tax-efficient investments less attractive. However, he introduces the concept of tax distributions, a mechanism that helps investors manage “phantom income“—income allocated to them without an accompanying cash distribution. Tax distributions allow investors to cover their tax liabilities without going out of pocket.
He explains that many private equity and real estate funds issue tax distributions to cover UBIT liabilities, ensuring investors have the cash needed to pay the IRS. These distributions are often at the highest tax rate, providing a safety net for investors dealing with phantom income. Bergman advises investors to negotiate the terms of these distributions to ensure they don’t negatively impact future returns.
Ultimately, while UBIT can be a significant concern for IRA investors, understanding and utilizing tax distributions can mitigate its impact. Bergman encourages investors to seek funds that offer these distributions and to negotiate terms that protect future distributions. He concludes by emphasizing the importance of being informed about UBIT and its implications, and invites listeners to subscribe to his content for more insights on tax strategies and alternative investments.
