As a general rule, UBIT applies to both IRAs and solo 401k plans; however, UDFI applies to IRAs but not to solo 401k plans.
Unrelated business Income Tax
The Unrelated Business Income Tax (UBIT) is assessed when a tax-exempt entity, such as an IRA or solo 401k plan, engages in a business activity that is not related to its general purpose. For example, if a self-directed solo 401k account is used to purchase a shoe store, the income generated from the business would be subject to UBIT. Reason being, selling shoes is no the general purpose of an solo 401k plan. This tax was created to keep tax-exempt entities on a level playing field with non-tax-exempt entities such as solo 401k plans and IRAs.
Unrelated Debt-Financed Income
Similar to the UBIT, there is a another tax called the Unrelated Debt-Financed Income (UDFI) tax on IRA investment income derived from debt-financed property, proportionate to the debt on the property. HOWEVER, UDFI does not apply to solo 401k plans so this is why individuals prefer solo 401k plans over IRAs for investing in real estate whereby a non-recourse loan will be used.
