Self-directed IRA investors utilizing alternative investments may face unexpected tax liabilities according to recent guidance from Next Generation Trust Company. The firm explains that certain types of alternative investments in self-directed IRAs can trigger two specific tax obligations: unrelated debt-financed income (UDFI) and unrelated business income tax (UBIT).
Jaime Raskulinecz, CEO of Next Generation Trust Company, emphasized the importance of investor awareness, stating that while self-directed IRAs are tax-advantaged accounts, these tax liabilities are triggered when specific conditions are met. The company provides full account administration and asset custody for self-directed IRAs and other self-directed plans.
UDFI refers to income generated by a financed asset within a self-directed IRA, commonly associated with real estate investments. This typically occurs when an investor uses a non-recourse loan to finance part of a real estate investment, such as vacation property or multifamily dwellings, in addition to IRA funds. The rent payments from such properties are considered unrelated debt-financed income because the IRA-held property was at least partially financed.
UBIT applies to earnings of $1,000 or more on investments that are at least partially financed. These earnings can be considered unrelated debt-financed income, which in turn becomes subject to unrelated business income tax. The taxes are paid specifically on the portion of the property that was financed through debt.
Beyond debt-financed income triggering UBIT, the guidance also identifies auxiliary income earned from truly unrelated business activity and income generated from unincorporated businesses in which the self-directed IRA has invested. The article provides detailed information about exemptions and the significant penalties associated with nonpayment of these required taxes. Failure to pay these taxes may jeopardize the entire self-directed IRA account.
Raskulinecz strongly recommends that investors conduct thorough due diligence and research before making nontraditional investments within self-directed IRAs. The company advises clients to consult trusted tax advisors before making investments to properly plan for and minimize the financial impact of any potential tax events. More information about self-directed IRAs and alternative assets is available at https://www.NextGenerationTrust.com.
