I thought my IRA was a tax-exempt account? Why do I owe UBIT or UDFI tax?
IRAs were created in order to encourage people to save for retirement. Therefore, any activity completed for a reason other than saving for retirement is characterized as “unrelated”. For example, if your IRA invests in a business such as a grocery store, the income generated by the store is considered unrelated to the purpose of an IRA according to the IRS. There are a few types of income that are generated by your IRA that are not taxable such as interest, dividends, rents, royalties, capital gains from a sale of a property, and profits under $1,000.
It is understandable that most people try to avoid taxes at all costs. However, incurring UDFI tax is not necessarily a bad thing; it means your investment is doing well. If you owe UDFI tax, your investment is generating more than $1,000 in profits. You’re obviously getting a great return!
