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Leveraging Your IRA UDFI Tax Law & Cases
IRC § 514(b)(1). UDFI tax is applied to income from “debt financed property” that is subject to “acquisition indebtedness.” Debt financed property is defined as property held to produce income that has acquisition indebtedness.
IRC § 514(b)(1). Additionally, debt incurred after the acquisition of property is acquisition indebtedness if such debt would not have been incurred without the property and if such debt were reasonably foreseen at the time of acquisition.
IRC § 514(9). 401(k) and other employer plans are exempt from UDFI taxes that arise from debt on real property.
IRC § 514 (9)(C)(ii). The tax code specifically exempts plans which are “qualified trusts” under section 401 from the tax code from UDFI tax.
Internal Revenue Manual, Part 2, 18.104.22.168. Unrelated Debt Financed Income, Gain From Sale or Other Disposition of Property, Treasury Regulations 1.514(a)-1(a)(v)(b), IRS Publication 598 (2012). UDFI tax at the time of sale works in a similar fashion to the example above, but the IRA is able to use the capital gain tax rate of 20% on profits subject to UDFI as opposed to being subject to the UBIT rate.
IRS Publication 598 (2012). The tax rates applicable to UBIT tax are the trust tax rates which cap out at a maximum rate of 39.6% at $11,950 of annual income subject to UBIT tax. The UBIT tax should be paid from the IRA’s funds and should not be paid with personal funds of the IRA owner.