IRA Financial’s Adam Bergman discusses the UBTI Tax and how it can affect the tax efficiency of your IRA or 401(k) plan., depending on how you invest.
In This Podcast
UBTI is a four letter word than many people are unaware of. Most investments in your retirement account are not subject to tax. They grow tax deferred (or tax free in the case of a Roth) so long as they remain in the account. However, there are some investments that will trigger the UBTI tax.
UBTI is defined as “gross income derived by any organization from any unrelated trade or business regularly carried on by it” reduced by deductions directly connected with the business. There are few ways the UBTI tax is triggered from a retirement plan investment.
First, is income from an active trade or business. The income generated from a business, such as a retail store or restaurant, will be subject to UBTI. Next, is business income generated from a passthrough entity, such as an LLC. Thirdly, the tax is triggered when you use margin to buy stock. Lastly, there’s a specific rule for IRAs when purchasing real estate. If you use a non-recourse loan to purchase a property, those funds are subject to the tax. It’s important to note that only the proceeds of the loan are taxable, not IRA funds used in conjunction with the loan. Also note that 401(k) plans have an exception to this rules. No UBTI tax is assessed when using non-recourse financing to purchase a real estate property with a 401(k) plan.
Since the whole premise of retirement plan is to save for the future in a tax-advantaged way, the UBTI tax might make an investment less tax friendly. It’s important to understand these rules when making an investment. For 2020, the tax can go as high as 37%. Not exactly the best way to invest your retirement money!
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Join us next episode as Mr. Bergman discusses the basics of the Individual Retirement Account, or IRA, how they work and the benefits of investing with one.
