When first confronted with the idea Unrelated Business Income Tax may be owed on IRA investments, most people are confused. One of the primary benefits of IRAs is the tax-free or tax-deferred savings, so when confronted with UBIT many ask, “why do I have to pay this tax?” and “isn’t it a double taxation?”
Taxation is only a small piece of the puzzle and should not deter investors from pursuing worthwhile investment opportunities when it is considered and accounted for correctly.
Did You Know Almost All Corporate Investments You Make Have a Form of Double Taxation?
When you invest in a publicly-traded stock you are paying something very similar to Unrelated Business Income Tax. Most investors are simply unaware that these traditional investments are taxed as well.
Almost all publicly-traded stocks are incorporated into what is known as a C-Corporation. This means that the earnings of the stock are taxed at the corporate level before net profits are calculated and then distributed to its investors (thus affecting the return on those earnings).
Most UBIT triggered investments are into what are known as “flow-through” entities such as Limited Partnerships (LPs) or Limited Liability Companies (LLCs). LPs and LLCs do not pay tax at the corporate level but rather the taxable income “flows through” the LLC/LP to the individual investors.
One of the reasons UBIT was instituted was to level the playing field between tax-exempt entities (including IRAs) that invest in or operate flow-through entities and those that are subject to the corporate tax of C-Corporations. Before UBIT was implemented by the federal government, income was able to “flow through” LLCs/LPs directly into tax-exempt entities without taxation. This provided an unfair advantage over their corporate-tax-paying counterparts, and thus UBIT was enacted.
As it relates to real estate IRA investments, UBIT is most commonly applied when debt-financing is utilized and only to the portion of the real estate that has been debt-financed. For more information about UBIT in the context of real estate IRA investments, please visit the Real Estate section of our website.
When Does a UBIT Taxable Investment in an IRA Make Sense? One Piece of a Large Puzzle
Taxation and UBIT is a small piece of the very large puzzle called retirement planning. While it is important to consider any taxation on investments, it is also important to keep that in perspective of the potential gains that can be achieved by the investment opportunity.
Increased access to opportunities can offer the potential for higher rates of return, and more avenues, which are beneficial even after the taxation is considered. Real estate and entity investing are two areas that have the potential to provide profitable returns for investors, even when UBIT is factored.