The reason some IRAs have to file tax returns and pay taxes comes down to unrelated business taxable income (UBTI). There are certain transactions that cannot be carried out through your IRA without incurring taxes. Here, we take a closer look at the types of business transactions that may require the IRA holder to file a tax return and pay taxes.
Hi I’m Joe, Founder of WealthFlex. Let’s take a quick look at why some IRAs need to file tax returns and pay taxes.
Not all transactions done in an IRA are tax advantaged. And some IRAs need to file a tax return called a 990-T. The issue that can result in an IRA having to file a 990-T is “unrelated business taxable income” or UBTI. IRAs are governed in a section of the treasury code that governs all tax-advantaged entities including non-profit organizations. Any income derived that is unrelated to the purpose of a tax-advantaged organization does not afford the organization the same tax benefits. In the case of an IRA, the purpose is for individuals to save for retirement. So, any activity not consistent with that in an IRA could be subject to taxation.
Let’s say your IRA were to buy a property for $1M, but only comes up with $1 as a downpayment and then it borrows the rest. Well, the income and gains from that investment would pay taxes on the leveraged portion, or the average asset acquisition indebtedness. So 99.999% of it would be taxed, and at the trust tax rates, which hits the 37% tax bracket at $12,951 in income.
This would be the same situation if your IRA were to purchase a percentage of any passthrough entity with those same facts.
Now, if your IRA were to purchase any portion of an entity that pays its own taxes, and doesn’t pass the business activity through to your IRA, then everything is fine. If you invest in Boeing stock with your IRA, for example, there’s no problem even though Boeing has acquisition indebtedness because Boeing pays its own taxes. If your IRA is a member of a passthrough LLC that borrows money to purchase assets, there could be UBTI, and you should speak to a tax professional.
The second area to be concerned about is the IRA engaging in business activity. Your IRA can buy an espresso cart and lease it out to someone who runs an espresso operation, but if your IRA hires a barista and uses the espresso cart to earn money, that income is UBTI. If your IRA’s UBTI is higher than $1,000 per year, you must file a tax return and the IRA itself pays taxes on it.
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Please note that the numbers used here are for illustrative purposes only. Yieldstreet cannot provide tax advice, so please consult a tax professional for advice specific to your situation.
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