If an IRA uses debt to buy an investment, then the income attributable to the debt is subject to UBIT.
If an IRA uses debt to buy an investment, then the income attributable to the debt is subject to UBIT. This income is referred to as “unrelated debt financed income” (UDFI), and it causes UBIT. The most common situation occurs when an IRA buys real estate with a non-recourse loan. For example, let’s say an IRA buys a rental property for $100,000, and that $40,000 came from the IRA and $60,000 came from a non-recourse loan. The property is thus 60% leveraged, and as a result, 60% of the income is not a result of the IRAs investment, but the result of the debt invested. Because of this debt, which is not retirement plan money, the IRS requires tax to be paid on 60% of the income. So, if there is $10K of net rental income on the property then $6K would be UDFI and would be subject to UBIT taxes.
For a more detailed outline on UDFI, please refer to my free one-hour webinar.