UBTI – Tax on Business Activities
Typically, a retirement plan or other tax exempt entity is not taxed on the income generated through its activities. This sheltering from taxation is one of the key advantages to investing with a tax-deferred or tax-free IRA or 401(k) plan.
An exception occurs, however, when a tax-exempt entity regularly engages in an activity that would be considered a trade or business. In this case, a tax is applied to what is referred to as Unrelated Business Taxable Income (UBTI).
Per IRS Publication 598:
“If an exempt organization regularly carries on a trade or business not substantially related to its exempt purpose, except that it provides funds to carry out that purpose, the organization is subject to tax on its income from that unrelated trade or business.”
The idea behind this law, which congress passed in the 1950’s well before IRA and 401(k) plans even existed, is that we do not want to create a competitive disadvantage for tax-paying businesses by allowing tax-exempt entities to compete with them on unequal terms.
When a tax-exempt entity has UBTI, the tax paid by the entity is referred to as Unrelated Business Income Tax or UBIT.
A sub-set of UBIT applies when a tax-exempt entity uses debt-financing such as a mortgage for a real estate investment property. This tax applies to Unrelated Debt-Financed Income or UDFI.
What Activities Generate UBTI?
UBTI only applies to certain types of activities that one might engage in with an IRA or 401(k) plan. Most retirement investments are passive in nature and therefore not considered subject to this tax. Examples of passive investments not subject to UBTI would include:
- Dividends
- Interest
- Royalties
- Rent from real property
- The sale of an asset that has been held over time to produce passive income
The test for whether the tax applies in an IRA or 401(k) has to do with the following criteria:
- Is the income generated from a trade or business activity?
- Is the activity engaged upon on a regular or repeated basis?
Examples of investments that might fall under this category would include:
- Operating income from ownership in a business such as a LLC or limited partnership that is treated as a pass-through for purposes of taxation, when that entity is engaging in an active trade – a restaurant, hotel, bookstore, auto shop, etc. Income from a partnership that purely holds passive investments would not typically be taxed. Note that dividends from a C corporation are not taxed, since the corporation will already have paid taxes on the income.
- Earnings on a loan to a business where the terms of the loan include participation in the profits of the business.
- Purchasing real property with the intent to fix it up and re-sell, otherwise known as flipping.
- Construction of real property with the intent to immediately sell.
- Renting or leasing personal property (not real property).
- Cryptocurrency mining & staking.
- Any kind of “dealer” activity that simply consists of buying and then reselling an asset.
UBTI Calculations
The calculation of UBTI taxation will vary depending on the type of activity being taxed. In general terms, the gross income produced by the activity will be subject to the tax. The taxable amount will then be reduced by allowable deductions for any costs directly associated with the production of income.
The tax is applied using trust tax rates, which range from 10% to 37% on various income brackets. The top 37% applies to income above $13,451 per year. In addition to the federal tax, many states have parallel tax.
Example – House Flipping
Assume you purchased a property using your IRA with the intent to have the house repaired and then resold for a profit. This is considered flipping, and the property is viewed as inventory held for sale in the normal course of business.
Let’s say you purchased the home at auction for $100,000 and then had repair work done prior to sale at a price of $200,000. This would result in a $100,000 gross gain on the transaction, which would be considered UBTI.
You would then be able to reduce the taxable income amount by the repair costs, as well as other expenses such as property taxes during the time the property was held, sales cost, etc. For sake of simplicity, let’s assume the total deductible expenses were $66,000, including $50,000 of rehab & holding costs and 8% for realtor commission and closing costs at the time of sale. This leaves a net taxable amount of $34,000.
Per the trust tax rate table for form 990-T, the tax amount would be $10,861. This leaves your IRA with $23,139 return on $150,000 invested. The project has produced a 15% net after tax return to your IRA. That is not bad, but there are probably less risky ways to generate a 15% return that do not have exposure to UBTI.
Example – Venture Capital
Venture Capital investments may have exposure to UBTI, but the impact may not diminish the appeal of the opportunity.
In a true venture capital play, the “prize” is the eventual sale of your IRA’s stake in a business at a higher price when the venture is sold or goes public. Only operating income is considered UBTI, not the gain in equity value. While there may be a UBIT component to the investment, it may not be significant. The start-up phase is not always profitable, and there may even be losses in the early goings that could be carried forward to offset UBTI in future profitable years. When the business hits the next level and you get to sell the shares your IRA purchased for $100 each at a price of $500, $1,000 or more, that gain in equity value is not taxed. Investing with IRA or 401(k) funds into such an opportunity can make a lot of sense.
If the primary motive for an investment in a business is the operating income the business will produce, however, the impact of UBIT may spoil the opportunity as an investment for a self-directed IRA or Solo 401(k) plan.
UBIT Blocker Strategies
If your self-directed IRA or Solo 401(k) strategy involves repeated trade or business activities that would generate UBTI, you essentially have three choices:
- Pick a different investment strategy that does not generate UBTI
- Engage in the activity, pay UBIT, and be satisfied with the net-after-tax returns
- Implement a UBIT blocker strategy to dramatically reduce the taxable impact
If the opportunities that are within your expertise and network are UBTI exposed – such as flipping houses – it may very well make sense to put your IRA to work in this fashion. A key benefit of a self-directed IRA or Solo 401(k) is to be able to “invest in what you know”, after all. With a UBIT blocker, you can have the ability to invest as you choose, but increase the profitability of the deals.
A UBIT Blocker is a taxable corporation inserted between a tax-exempt entity and a UBIT exposed transaction. This strategy does not eliminate tax exposure, but rather reduces the taxable rate. Instead of the gains from a transaction being taxed at the higher 37% trust tax rates, normal corporate tax rates of 21% will apply. The underlying IRA or 401(k) plan then receives the after-tax profits of the deal as tax-sheltered dividend income from the blocker entity.
Such structures have been around for a long time, but were not particularly beneficial when the top corporate tax rate was 35%. With the passage of the 2017 Tax Cuts and Jobs Act, the corporate tax rate has been lowered to 21%. This is a significant enough savings that the use of a blocker corporation may be beneficial for those investors wanting to engage in trade or business activities such as house flipping with their self-directed retirement plan.
Revisiting the Flip Example with a UBIT Blocker
If we take the prior home flip example and insert a UBIT Blocker between the IRA and the transaction, the resulting profitability of the deal is markedly improved.
By taking the net income of $34,000 and applying a 21% corporate tax rate instead of the effective UBIT rate, the taxable amount is reduced by over $4,500 to $7,140. This results in a net after-tax profit of $26,860 that can be issued by the blocker entity as a dividend to the underlying IRA or 401(k) plan. That changes the ROI for the deal from 15% to 18%, which is much more appealing. If you repeat the flip process multiple times per year, the savings generated by the blocker entity can be significant.
Reporting
A return must be filed if the total income generated through a business activity exceeds $1,000 for the year. UBTI is calculated and reported by the IRA or 401(k) using IRS form 990-T, and is not associated with your personal return. This return has an April 15th filing deadline. If the total tax liability will exceed $500 for the year, quarterly estimated tax payments may be required.
In summary
At first blush, one might decide that exposure to taxation would rule an investment opportunity as unfavorable for your retirement plan. While this tax does generate additional overhead through both the tax itself and the costs of preparing a return, you need to keep an eye on the bottom line. If the after UBIT return on a deal is superior to other opportunities available to your plan, it may still make sense to move forward.
If you will be engaging in a series of UBTI exposed transactions over time, the use of a UBIT Blocker entity may be a viable strategy.
If you are considering making an investment that will have exposure to UBTI, you should consult with your tax advisor in advance to gain a clear picture of the impact the tax will have in your specific situation.
Resources:
IRS Publication 598 – Tax on Unrelated Business Income of Exempt Organizations
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Quick answers to common questions
We’ll take you through a simple, step by step process designed to put your investment future into your own hands…immediately. Everything is handled on a turn-key basis. You take 100% control of your Retirement funds legally and without a taxable distribution.
YES! In 1974, Congress passed the Employee Retirement Income Security Act (ERISA) making IRA, 401(k) and other retirement plans possible. Only two types of investments are excluded under ERISA and IRS Codes: Life Insurance Contracts and Collectibles (art, jewelry, etc.). Everything else is fair game. IRS CodeSec. 401 IRC 408(a) (3)
It’s actually pretty simple. Early on, regulators let the securities industry take the lead in educating the public about retirement accounts. Naturally, brokers and banks promoted stocks, bonds, and mutual funds—giving the impression that those were the only allowed investments. That was never true... and still isn’t. You can probably guess why they kept the rest under wraps.
It is possible to use funds from most types of retirement accounts:
- Traditional IRA
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Keogh
- 401(k)
- 403(b)
- Profit Sharing Plans
- Qualified Annuities
- Money Purchase Plans
- and many more.
It must be noted that most employer sponsored plans such as a 401(k) will not allow you to roll youraccount into a new Self-Directed IRA plan while you are still employed. However, some employers will allow you to roll a portion of your funds. The only way to be completely sure whether your funds are eligible for a rollover is by contacting your current 401(k) provider.
A Solo 401(k) requires a sponsoring employer in the format of an owner-only business. If you have a for-profit business activity – whether as your main income or as a side venture – and have no full-time employees other than potentially your spouse, your business may qualify. The business may be a sole-proprietorship, LLC, corporation or other entity type.
A self-directed retirement plan is a type of IRA or 401(k) that gives you greater control over how your retirement funds are invested. Unlike traditional accounts held at banks or brokerage firms that limit you to stocks, bonds, and mutual funds, self-directed plans allow you to invest in a wide range of alternative assets including real estate, private businesses, precious metals, cryptocurrency, and more.
These plans still follow the same IRS rules and maintain the same tax-deferred or tax-free benefits as conventional retirement accounts. The difference is simply in how and where you choose to invest.
No. Moving to a self-directed IRA or Solo 401(k) does not trigger any taxes, as long as your funds are eligible for rollover.
Self-directed retirement plans maintain the same tax-advantaged status as traditional plans offered by banks or brokerage firms. The key difference is flexibility—our plans are designed to give you greater control and allow for a wider range of alternative investments beyond stocks, bonds, and mutual funds.
A prohibited transaction is any action between your retirement plan and a disqualified person that violates IRS rules and can lead to serious tax consequences. Under IRS Code 4975(c)(1), prohibited transactions include:
- Selling or leasing property between your plan and a disqualified person Example: Your IRA cannot purchase a property you already own.
- Lending money or extending credit between the plan and a disqualified person Example: You cannot personally guarantee a loan your IRA uses to buy real estate.
- Providing goods or services between your plan and a disqualified person Example: You can’t use your personal furniture to furnish a rental property owned by your IRA.
- Using plan income or assets for the benefit of a disqualified person Example: Your IRA cannot buy a vacation home that you or your family use.
- Self-dealing by a fiduciary (using plan assets for their own benefit) Example: Your CPA shouldn't loan your IRA money if they’re advising the plan.
- Receiving personal benefit from a deal involving your IRA's assets Example: You can’t pay yourself from profits your IRA earns on a rental.
If a transaction doesn’t clearly fall within the allowed guidelines, the IRS or Department of Labor may review the situation to determine if it qualifies as a prohibited transaction.
Disqualified persons are individuals or entities that are prohibited from engaging in certain transactions with your IRA or 401(k). Doing so could trigger a prohibited transaction, which may result in taxes and penalties.
Here’s who is considered a disqualified person:
- You (the account holder)
- Your spouse
- Your parents, grandparents, and other ancestors
- Your children, grandchildren, and their spouses
- Any advisor or fiduciary to the plan
- Any business or entity owned 50% or more by you or another disqualified person, or where you have decision-making authority
These rules exist to prevent self-dealing and ensure your retirement plan remains in compliance with IRS regulations.
(Reference: IRC 4975)
Understanding and following these rules can be tricky, but it’s very doable. The best way to stay compliant is to work with professionals who specialize in self-directed retirement plans. They can help you navigate IRS guidelines and avoid prohibited transactions.
If an IRA holder is found to have engaged in a prohibited transaction with IRA funds, it will result in a distribution of the IRA. The taxes and penalties are severe and are applicable to all of the IRA’s assets on the first day of the year in which the prohibited transaction occurred.
Yes. While self-directed retirement plans allow for a wide range of investments, there are a few important restrictions.
You cannot invest in collectibles or life insurance contracts, and you must avoid prohibited transactions—activities that benefit you personally rather than the retirement plan. These include things like buying or selling property to yourself or family members, using plan assets for personal gain, or self-dealing in any way.
Violating these rules could cause your entire IRA to lose its tax-advantaged status. To protect your account, it’s essential to work with professionals who understand IRS regulations and can help you stay compliant.
This is a common misconception. In many cases, professionals may simply be unfamiliar with self-directed retirement plans, as they fall outside their usual scope of work. CPAs and tax preparers are trained to file taxes, not necessarily to advise on alternative retirement strategies. Financial advisors and brokers often work for firms that focus on traditional investments like stocks and mutual funds—and may not benefit from or support alternative options like real estate or private lending.
Self-directed retirement investing is legal under IRS rules—but like any specialized area, it requires working with professionals who understand how it works.
The IRS has rules in place to make sure your IRA is used only for the exclusive benefit of the retirement account—not for personal gain or to help family members. These rules can get complicated because there are many ways a conflict of interest can occur, even unintentionally.
For example, if your IRA buys a house and rents it to your mother, you might be reluctant to evict her if she stops paying rent. That emotional connection creates a conflict between what’s best for your IRA and your personal relationships, something the IRS aims to prevent.
These rules help ensure your retirement account stays compliant and protected. (See IRC 408)
Yes. Most tax-deferred retirement accounts—such as Traditional IRAs, old 401(k)s, 403(b)s, and TSPs—can be rolled over into a self-directed IRA or Solo 401(k), depending on your eligibility. Roth IRAs cannot be rolled into these accounts.
You can contribute directly from earned income, subject to annual IRS contribution limits. The method and amount depend on the type of plan you have (e.g., Solo 401(k) vs. IRA).
To take a distribution, you'll request funds through your custodian or plan administrator. Distributions may be taxable depending on your account type and age. Early withdrawals may be subject to penalties.
For 2025, the Solo 401(k) max contribution limit is $81,250 if age 60-63, $77,500 if age 50-59 or 69+, and $70,000 if under 50. Traditional and Roth IRAs have a limit of $7,000 ($8,000 if age 50+). Limits are subject to IRS adjustments.
Yes. IRA contributions are typically due by your personal tax filing deadline (e.g., April 15). Solo 401(k) contributions follow your business tax filing deadline, including extensions.
IRS reporting requirements vary depending on the type of self-directed retirement plan you have. Here’s a quick breakdown of what you need to know
Please note: Our team can help you understand what’s required for your specific account, but we don’t provide tax or legal advice. We always recommend working with a qualified tax professional to ensure full IRS compliance.
Self-Directed IRA (Traditional or Roth)
- Form 5498 – Filed by your custodian each year to report contributions, rollovers, and the fair market value (FMV) of your account.
- Form 1099-R – Issued if you take a distribution or move funds out of your IRA.
- Annual Valuation – You'll need to provide updated FMV for any alternative assets held in the account, such as real estate or private placements.
Solo 401(k)
- Form 5500-EZ – Required if your plan assets exceed $250,000 as of year-end. Must be filed annually by the plan participant.
- Form 1099-R – Required if you take a distribution or roll funds out of the plan.
- Contribution Tracking – Keep records of employee and employer contributions. These are not filed with the IRS but may be needed for tax reporting or audits.
SEP IRA
- Form 5498 – Filed by your custodian to report contributions and FMV.
- Form 1099-R – Filed by your custodian. Issued for any distributions.
- Employer Contributions – Must be reported on your business tax return (and on employee W-2s, if applicable).
Health Savings Account (HSA)
- Form 5498-SA – Filed by your HSA custodian to report contributions.
- Form 1099-SA – Filed by your HAS custodian. Issued for any distributions.
- Form 8889 – Must be included with your personal tax return to report contributions, distributions, and how funds were used.
