How to Calculate Unrelated Business Income Tax on My Real Estate IRA
Unrelated Business Income Tax or UBIT was introduced by congress in 1950. The intent of UBIT was to give tax exempt entities less of an advantage over other types of corporations or individuals when it comes to taxes owed. There are certain qualifications that determines whether or not UBIT is owed but the only qualification that will be examined in this blog post is in regards to debt financing with an IRA non-recourse loan.
When my client wanted to have his taxes done his CPA didn't know how to calculate UBIT. I asked my CPA and he was just as dumbfounded when it came to UBIT calculations. This just goes to show that only a small portion of the population are taking advantage of IRA non-recourse real estate loans to leverage their retirement investments. The figures needed in order to calculate UBIT are the debt figure used to secure the real estate investment (loan amount), the cost of the investment and the net taxable income generated by said investment property.
Lets says that a $300,000 property was secured with an IRA loan of $165,000. You must determine the average acquisition indebtedness by taking the principal loan balance owed at the beginning of each month for the months in the taxable year. So if we take 6 months for the fiscal year and if $1,000 less was owed on each new loan statement we would take $165,000 + $164K + $163K + $162K + $161K + $160K then divide that sum by six for an average acquisition indebtedness (AAI) of $162,500.
Then to determine the average cost basis for the tax year you would take the purchase price minus the depreciation. Lets say the depreciation for the tax year is $10,000 to keep this simple. You add the $300,000 purchase price to $290,000 (ending cost basis after subtracting the depreciation) and get $590,000. $590,000 divided by two to gives the average cost basis of $295,000.
The third and final piece to the UBIT equation is net income. Lets say that the rental income was $37,500 and after subtracting all of the operating costs such as taxes, insurance, interest, repairs, management, depreciation, maintenance, etc., the net income comes out to be $6,000.
Taking our three pieces of the equation, we take the AAI of $162,500 divided by the average cost basis of $295,000 and we multiple that figure by the net income of $6,000 and we get an unrelated debt finance income of $3,305.08. The UBIT would be based on this income amount. I'm not a CPA but I believe that the tax rate on this would be somewhere near 15 % and that would equal an UBIT of around $500. This tax is much less than the amount owed for regular income tax purposes if the entity was owned with taxable funds. This example is simply for educational purposes and more information regarding UBIT can be found here.
The content of this blog post was derived from Leverage Your IRA by Matthew M. Allen.
How to Calculate Unrelated Business Income Tax on My Real Estate IRA
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