UBIT or UBTI Defined
Since retirement accounts such as IRAs and 401ks are tax deferred (i.e., don’t pay taxes until distributions commence, usually at retirement) and can invest in businesses, they are in direct competition with businesses that pay taxes. Therefore, this is seen as disadvantageous to tax-paying businesses outside retirement accounts. As a result, to level the playing field the IRS requires IRAs and 401ks that invest in a business to pay UBIT on net income generated from their investment in that business.
UBIT or UBTI onReal Estate does not apply to Solo 401k (Self-Directed 401k)
While tax deferred accounts such as IRAs are generally subject to payment of UBIT when investing in alternative assets like real estate that are debt financed (leveraged), qualified plans such as Solo 401k Plan (commonly referred to as self-directed 401k, self-directed solo 401k, solo K or Individual 401k) are not subject to UBIT on debt financed real estate. Real estate in a Solo 401k is not subject to UBIT because it’s considered passive income. Other investment types that generate passive income include stocks, bonds, mutual funds, and money market accounts.
UBIT or UBTI Applies to Trade or Business
However, just like IRAs, a Solo 401k Plan is subject to payment of UBIT on income generated from its investment in an operating business like an LLC or partnership that generates pass-through income. When a Solo 401k generates profits from a business, the net income is subject to payment of tax just like a business outside the Solo 401k to put it on the same playing field as the tax-paying entity that invested outside a solo 401k. So, for example, a Solo 401k that generates net income from investing in a shoe store will be subject to UBIT because the shoe store is considered an operating company.
UBIT/UBTI Facts for: Solo 401k | Self-Directed Solo 401k | Self-Directed 401k
- UBIT does not apply to Solo 401k real-estate purchases.
- UBIT does apply to Solo 401k that invests in a trade or business.
- UBIT is paid only on income of $1,000 or more from a trade or business
- UBIT is reported to the IRS on Form 990T, Exempt Organization Business Income Tax Return.
- UBIT falls under IRC Sec 511, and exceptions are found in Publication 598, Tax on Unrelated. Business Income of Exempt Organizations.
- UBIT must be paid with Solo 401k funds not personal funds.