This article was originally contributed by Forrest Moore, Senior Account Manager for Guidant Financial Group. Forrest is an expert in the field of self-directed retirement plans.


With the popularity of self-directed IRA investing at an all time high (and growing quickly), there is a decent chance that you or someone you know is using retirement funds to purchase real estate, invest in loans, buy a business, participating in a private placement or other “non-traditional” investments. Self-directed IRA holders have many more investment options available to them then those offered through a traditional brokerage house.

It is important to understand what you can do with a self-directed IRA but it is just as important to know what you cannot. Most self-directed IRA investors know that it is prohibited to invest retirement funds in life insurance, collectibles or any investment that involves a “disqualified person” (certain close relationships). One important factor that impacts the investment choices of self-directed IRA investors and is often overlooked or misunderstood is Unrelated Business Taxable Income or UBIT. UBIT is a special tax that Congress created to apply to tax-exempt entities that produce income from business activity rather than passive investments. In addition to churches, charities and non-profits, IRAs are also affected by UBIT. The focus of this article is how this can impact a self-directed IRA.

Many passive investments that your IRA might pursue are exempt from UBIT. Some examples of exempt income to an IRA would include interest from loans, dividends from securities, real estate rental incomes and the proceeds of the sale of real estate that was held for appreciation. These kinds of income are often referred to as “passive.”

The types of income that could subject an IRA to UBIT those earned from the sale of a product or service, whether retail or wholesale and regardless of ownership percentage. If your IRA buys a gas station and earns its income from the sale of gasoline, potato chips and cigarettes, this income is clearly business income – you were selling (or exchanging) products. (Such an investment would be impractical as well because if your IRA owned the asset you would be barred from working for or managing that store personally or even shopping there!) Where self-directed IRA investors are most likely to encounter UBIT is in certain types of real estate projects. However this is where the most confusion is found.

The types of real estate projects where a self-directed IRA investor would most commonly face UBIT are on the profits generated as a result of rehab/flips or development /construction projects that result in resale. In contrast, incomes from properties purchased for appreciation and/or rental incomes are exempt from taxation in an IRA, unless the property is purchased on leverage—which is an entirely different topic that will be covered in a separate article to follow. The area where investors (and OFTEN their tax advisors!) get confused is in determining which projects produce business income (where UBIT would apply) or simply passive, tax exempt income.

The IRS and the tax courts use a series of tests (There are up to 10 factors that can be considered) to determine if an activity is a passive investment or a business activity. No single one of these factors is more important that the others, and no one factor is determinative. Here are some of the most common tests used in no particular order:

1. Intent – Did the individual buy the property with the intent to hold the property for appreciation? Or did the individual buy the property to resell it quickly? If the intent was to hold for appreciation this is a strong indication that it is an investment and not taxable to the IRA. If the intent was for resale that is a strong factor that the activity will be deemed a business and taxable to the IRA.

1. Development or Construction – In general development or construction activities are considered to be activities that are designed to increase the value of the asset through action as opposed to appreciation. Development or construction activities are factors that imply the activity is business-related and therefore taxable in the IRA.

1. Holding Period – The longer the property is held from either the original purchase price or from the completion of development or construction the less likely the income will be subject to UBTI when it is eventually sold. In most cases one year from the completion of development or construction is considered the minimum length of time the property should be held to offset the business factors of any development or construction activities that have occurred – but that must be discussed with a qualified tax professional.

1. Marketing – Marketing activities include any activities that are designed to attract a potential buyer. The longer you advertise and the more aggressive the marketing, the more likely your investment may be considered a business and be subject to UBTI.

1. Inventory Replacement – If your IRA sells an asset and then replaces that asset with another similar asset to be sold this is holding the property only as inventory. The more rapid or frequent the replacement and resale cycle the more likely that UBTI taxes will apply.

If you are considering using a self-directed IRA to invest in non-standard assets you should consult with a qualified tax professional to gain a better understanding of the potential tax implications. Because no one factor is determinative it is important to take all of these factors in to account. Your tax advisor may even bring up other factors to consider depending on your IRAs specific investments. If you understand and account for each of these factors then real estate investment can be an excellent way to grow an IRA.