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UBTI and UBIT in IRAs and Qualified Plans: Identifying
Unrelated Business Taxable Income and Avoiding UBTI Tax Traps
WEDNESDAY, AUGUST 24, 2016, 1:00-2:50 pm Eastern
FOR LIVE PROGRAM ONLY
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FOR LIVE PROGRAM ONLY
Aug. 24, 2016
UBTI and UBIT in IRAs and Qualified Plans
Bill Humphrey, Co-founder and CEO
New Direction IRA, Louisville, Colo.
bhumphrey@ndira.com
Israel Tannenbaum, Senior Manager
WeiserMazars, New York
israel.tannenbaum@weisermazars.com
Notice
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY
THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY
OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT
MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR
RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.
You (and your employees, representatives, or agents) may disclose to any and all persons,
without limitation, the tax treatment or tax structure, or both, of any transaction
described in the associated materials we provide to you, including, but not limited to,
any tax opinions, memoranda, or other tax analyses contained in those materials.
The information contained herein is of a general nature and based on authorities that are
subject to change. Applicability of the information to specific situations should be
determined through consultation with your tax adviser.
UBTI and UBIT in IRAs and Qualified Plans: Identifying Unrelated Business Taxable Income and Avoiding UBTI Tax
Traps
ISRAEL TANNENBAUM, CPA Senior Manager, WeiserMazars LLP
Israel has over a decade of experience serving not-for-profit clients in a range of subsectors. He specializes in delivering insightful, comprehensive tax services and is particularly adept with Forms 990, 990-PF, 990-T, 926, 8865, 5471, 5500 and any relevant state forms, including Form CHAR500 and CT-13. Israel’s other clients have included Fortune 100 companies and large pension trusts. Israel currently oversees the Not-For-Profit Tax Practice at WeiserMazars LLP. Prior to joining WeiserMazars, Israel was a Director at Loeb & Troper LLP, where he oversaw the entire tax function of the firm. He also spent ten years at a Big 4 accounting firm as a Senior Manager in the Tax Practice. Israel also has significant experience assisting clients with implementation of the requirements of various new legislation and regulations such as the New York State Not for Profit Revitalization Act and the 2014 IRS Final Tangible Property Regulations Israel received his BBA in Accounting, with honors, from Baruch College. He is a Certified Public Accountant in New York State, and a member of the American Institute of Certified Public Accountants and the New York State Society of CPAs, where he sits on the Exempt Organizations and Not-for-Profit Organizations Committees.
CONTACT
WeiserMazars LLP
Israel Tannenbaum| Senior Manager
135 West 50th Street
New York, NY 10020
(P) 646.225.5915
(Email) Israel.Tannenbaum@WeiserMazars.com
6
BILL HUMPHREY, CPA CEO, New Direction IRA, Inc.
Contact
New Direction IRA, Inc.
Bill Humphrey | CEO
1070 W. Century Dr. Ste. 101
Louisville, CO 80027
(p) 303-546-7930, ext. 142
(email) bhumphrey@ndira.com
Bill is recognized in the industry as an expert in self-
directed IRAs, HSAs, and other tax-advantaged
accounts, as well as the IRS codes pertaining to these
investments. Bill has taught courses on retirement plan
investment rules to investors, CPAs, and investment
professionals through a variety of venues, including the
University of Denver’s School of Law.
An experienced Certified Public Accountant, Bill has
focused on income tax, auditing, tax-related real estate
issues, and forensic accounting for more than 20 years.
Bill is well versed in IRA law and is current with all
legislation governing tax-advantaged plans. Bill has
served as a consultant to HSA platform providers, and
is a leader in promoting the idea of investing HSA
assets long term for medical costs in retirement. He has
been involved in real estate investment and has
assisted in developing the framework for debt-
leveraged IRA real estate investment.
Bill received his Bachelor of Science degree in
Business from the University of North Carolina, Chapel
Hill, with a concentration in accounting and computer
science. He rounded out his technical background with
graduate study in finance, accounting, and economics
at the University of Colorado, Boulder.
7
WeiserMazars LLP is an independent member firm of Mazars Group.
A G E N D A
8
UBTI generating assets in IRAs and other qualified plans
Self-directed IRA reporting
IRA trusts and other vehicles holding UBTI assets
Identifying and calculating UBTI
Filing Form 990T
9
Is UBIT a Prohibited Transaction or
Illegal?
Unfamiliarity results in fear
No, it’s just a tax
The tax code does not prohibit leverage within an IRA or
Alternative Investment within a Retirement Plan
Many accountants are not familiar with it
9
WeiserMazars LLP is an independent member firm of Mazars Group.
P R U D E N T I N V E S T M E N T S T A N D A R D
10
The Employee Retirement Income Security Act of 1974 (“ERISA”) requires that
fiduciaries:
Diversify plan investments
Act for the “exclusive purpose” of the plan
Act with prudence
Act in accordance with the “terms of the plan”
WeiserMazars LLP is an independent member firm of Mazars Group.
I S S U E S T O C O N S I D E R
11
Alternative Investments hold both distinct advantages and disadvantages for
Qualified Plans:
Liquidity
Transparency
Fees
WeiserMazars LLP is an independent member firm of Mazars Group.
W H A T I S U N R E L A T E D B U S I N E S S I N C O M E
( “ U B I ” ) ?
12
“Income from a trade or business, regularly carried on, that is not substantially
related to the charitable, educational or other purpose that is the basis of the
organization’s exemption.”
The following three criteria must be present:
• A trade or business
• Regularly carried on
• Not substantially related
WeiserMazars LLP is an independent member firm of Mazars Group.
T R A D E O R B U S I N E S S
13
IRC Sec 513 (c)
Trade or business includes any activity which is carried on for the
production of income from the sale of goods or the performance of
services
• Must produce a profit to be considered a trade or business, however
no part of a trade or business shall be excluded from the
classification as unrelated trade or business merely because it does
not result in a profit
• Consistent losses could result in disqualification as a “trade or
business”
WeiserMazars LLP is an independent member firm of Mazars Group.
R E G U L A R L Y C A R R I E D O N
14
Reg. Sec. 1-513-1 (c)
Trade or business must be regularly carried on
IRS generally compares time span of comparable commercial activity to time
span of activity conducted by exempt organization
• Activities engaged in only periodically will not be considered regularly
carried on if they are conducted without the competitive and
promotional efforts typical of commercial endeavors
• Income producing or fundraising activities lasting only a short period
of time on an annual basis would not be considered regularly carried
on
• Example: Annual Charity Bake Sale
WeiserMazars LLP is an independent member firm of Mazars Group.
N O T S U B S T A N T I A L L Y R E L A T E D T O E X E M P T P U R P O S E
15
IRC Sec. 513(a)
Any trade or business, the conduct of which is not substantially related to the
performance of the plans basis for exemption.
Activity must contribute importantly to the accomplishment of the exempt
purpose
Whether a trade or business is substantially related to an organization’s
purpose depends on the facts and circumstances
Destination of the income does not matter
Publication 598
16
17
Origins of UBIT
Qualified Pension and 401k Plans (may meet an exemption for
debt-financed investment)
Non-profits
Applies to IRAs, both Roth and Traditional
17
18
When Does UBIT Occur ?
Debt-financed IRA/Qualified Plan purchases
Operating a business within an IRA
Sale of debt-leveraged property
Owning a pass-through (untaxed) entity operating a business *
* IRAs are not eligible S – Corp
shareholders although 401ks and
other Qualified plans are.
18
19 19
A Tax By Any Other Name…
UBIT
Unrelated Business
Income Tax
UBTI
Unrelated Business
Taxable Income
UDFI
Unrelated Debt
Financed Income
Same or Different?
19
20
Rental Income Untaxed
Business Income
UBIT
Sale of
Debt-Leveraged
UDFI UDFI
Subject to U B I T
20
WeiserMazars LLP is an independent member firm of Mazars Group.
A L T E R N A T I V E I N V E S T M E N T U B I T
21
Alternative
Investments Include:
Hedge Funds, Private
Equity Funds, Real
Estate Investments,
Derivatives
Foreign Filings
State Tax
Considerations
Activities and income of
these investments are
attributable to the
exempt organization
based on their
ownership
22
Working Definition - UDFI
On net income after deductions (including depreciation)
Only on the % of net income attributed to debt-financing
Applies to sale of property based on debt financed portion
Applies to rental income from real property
22
23
Other UBIT / UDFI Facts
• Yes, but securities create the same issue because they pay
taxes before your IRA received dividends
Who pays the tax bill? • The IRA/Qualified Plan pays the tax bill
When are tax payments necessary? • If the IRA/Qualified Plan generates taxable net income over
$1,000
• Frequently no tax bill for the first 5 to 8 years due to depreciation
Isn’t that double taxation?
23
24
UBIT Facts Based on ratio of 12
month avg. loan balance
to depreciated basis of
property At sale taxed at unrecap.
sect 1250 gain & rest cap
gains rate (debt financed
portion) Operating income taxed
using Trust rate (debt
financed portion only)
401(k) and Qualified
Pension Plans may be
exempt Always “run the numbers”
on case by case basis
24
Form 1065 Schedule K-1
25
Form 1065 Schedule K-1
26
WeiserMazars LLP is an independent member firm of Mazars Group.
F O R M 1 0 6 5 S C H E D U L E K - 1
F O O T N O T E S
27
How much UBIT will be paid?
28
Calculated at trust rate:
Only on income “brought in”
by extra buying power of debt
Extra
Income 35% MAX
28
WeiserMazars LLP is an independent member firm of Mazars Group.
A L L O C A T I O N O F E X P E N S E S
29
Alternative Investments will also pass through any expenses and losses
to offset UBI
Net operating loss [IRC §172]
Taxed at trust rates for qualified plans (or corporate rates for
organizations set up as corporations such as most 501(c)(3) exempt
organizations) on NET unrelated business income
- Expenses can reduce or even eliminate UBTI!
WeiserMazars LLP is an independent member firm of Mazars Group.
A L L O C A T I O N O F E X P E N S E S ( C O N T ’ D )
30
$1,000 specific deduction
- That’s why organizations with gross receipts from unrelated
activities of less than $1,000 are not required to file a Form 990-T
- Specific deduction cannot be taken if they have a net operating loss
(NOL)
Other Deductions
- Tax preparation fees
- Unrelated business income consulting fees
- State UBIT paid
IRA calculates rental income just like an
individual would
• Income
• Less expenses
– Taxes
– Insurance
– Management
– Interest
– Operating
– And Tax Depreciation
• = Net Rental Income
31
Tax depreciation is used for tax calculation
32
IRA/Qualified Plan reports only debt
financed portion as income
Average Debt Balance
Divided by
Average Adjusted Basis
Debt Financed % X Net Rental Income = UBI
33
NOL carries forward to subsequent years
34
A quick example
• Covers income from
rental operations
• Covers sale of
property
35
John’s IRA buys an investment property using a
non-recourse loan:
Cost of Property: $ 500,000
IRA Investment: $ 200,000
Non-recourse Loan: $ 300,000
Leverage: 60%
Mortgage Payment: $ 1,600 / month
Taxes & Insurance: $ 400 / month
36
Other Information:
Rent: $ 2,500 / month
Utilities: Paid by tenant
Net Cash Flow: $490 / month = $5,874 /
year
Depreciation: $14,545 / year
Interest Expense: $ 14,720 (4.95%)
Net Loss Year One: ($4,265)
Annual Appreciation: 2.5%
37
Year 8
Rent: $ 2,951 / month, T&I $475
Utilities: Paid by tenant
Net Cash Flow: $876 / month = $10,512 /
year
Depreciation: $14,545 / year
Principal Payments: $ 6,318
Interest Expense: $12,876
Net Income Year Eight: $2,296
38
Calculation of UBIT on Year 8’s Income:
Debt Balance / Depreciated
Basis:
$ 263,835 / $398,182 =
66.26%
Net Income x 66.26%: $ 1,521
UBI $ 1,521 - $1,000 = $521
Tax: ~ $104
39
Calculation of UBIT On Sale in Year 8:
Sale Price: $ 609,201
Costs of Sale (3%): $ 18,276
Net Proceeds: $ 590,925
Current Year Debt-
Financed %: 66.26%
Capital Gain ($590,925 -
$426,587): $ 164,338
UBI Portion: $108,757
UBIT: $ 23,665
40
Account Value
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
Year 1 Year 8
Debt Financed RealEstate IRA
Annual Return =12.1%
41
Filling Out the 990T
42
WeiserMazars LLP is an independent member firm of Mazars Group.
F O R M 9 9 0 - T R E P O R T I N G
43
Form 990-T is required:
(Any organization with annual gross unrelated business income of $1,000 or more)
Filed in addition to Form
990, Form 990-EZ or 990N
Form 990-T is due:
(The 15th day of the 4th month (5th
month for Section 501(c)(3)
organizations) following the end of
the tax year for Section 401 (a)
trusts)
WeiserMazars LLP is an independent member firm of Mazars Group.
F O R M 9 9 0 - T R E P O R T I N G ( C O N T ’ D )
44
If the organization incurs UBIT In excess of $500.00 during
the fiscal year, it must make quarterly estimated tax
deposits prior to filing its tax return (Form 990-W)
State/Foreign returns are due with the federal 990-T
(States have varying rules regarding estimated tax payments)
Sample – debt leveraged
rental property 532000
X
X
X
50,750 42,370
42,370 50,750 8,380
8,380
Special Tax ID
Page 1 Part 1
45
Page 1 Part 2
20,513
20,513
8,380
8,380
1,000
7,380
46
x 1,752
1,752
1,752
1,752
1,752
0
0
Page 2 Part 3
47
Page 2 Part 5
x
x
x
x
48
Page 3
49
Page 3 – Schedule E
72,500 40,015 20,513
700,000 50,750 42,370
42,370 50,750
1,000,000 70%
RENTAL PROPERTY
50
Page 4 of 4 - N/A
51
Debt financed percentage is tracked
by property
Average Debt Balance
Divided by
Average Adjusted Basis
Average Debt Balance
Divided by
Average Adjusted Basis
Average Debt Balance
Divided by
Average Adjusted Basis
52
Debt payoff can be directed to
specific loans
53
Taxes on gains rolled into
subsequent properties may be
avoided/reduced
54
55 55
May occur at the sale
of the property
Key Points
Is only charged on the
debt leveraged
portion of the net
income
May occur when there
is taxable rental
operating income
over $1,000
Is not against the
rules
Should be considered
as another expense
when doing your rate
of return analysis
May carry forward
losses to offset future
income
UBIT
55
56
Should you leverage your IRA to make a
Real Estate Purchase?
Rental Income &
Vacancy
Operating Expenses Reserves for
Contingencies
% Loan to Value Bank Terms Future Appreciation
Do the calculations.
Look at:
56
57
How to Avoid UBIT from UDFI
Pay off debt 12 months before you sell the property
Do not leverage property
Offset taxable gains with losses
Do a 1031 Exchange within the IRA
57
New Direction IRA
1070 W. Century Dr.
Suite 101
Louisville, CO 80027
303/546-7930
877/742-1270
info@ndira.com
www.NewDirectionIRA.com
WeiserMazars LLP
Israel Tannenbaum| Senior Manager
135 West 50th Street
New York, NY 10020
(P) 646.225.5915
(Email)
Israel.Tannenbaum@WeiserMazars.com 58
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