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“Self-Directed IRA Investors: Beware the Specter of UBTI,” Tax Notes Federal

May 6, 2024

Phil Karter's article “Self-Directed IRA Investors: Beware the Specter of UBTI” in Tax Notes Federal

In an article published in Tax Notes Federal on May 6, 2024, Philadelphia-based Shareholder Phil Karter discussed investment income from self-directed IRAs and how it might be considered unrelated business taxable income (UBTI).

The first three paragraphs of the article are included below with permission from the publication. To read the full article, subscribers may click here.

Much has been written in recent years about the increasing popularity of self-directed IRAs, which allow retirement investors the flexibility to invest in a broad array of investment alternatives not offered by most traditional brokerage firms. Whereas traditional retirement accounts typically limit investments to stocks, exchange-traded funds, mutual funds, and bonds — and may use the term “self-directed” to connote that the investor, as opposed to a manager, chooses from among them — a true self-directed IRA can participate in almost any type of alternative investment, such as private equity, private lending, precious minerals, collectibles, and cryptocurrency, to name a few examples.

For those considering this form of retirement investment, it is important to be aware of the pitfalls inherent in self-directed IRAs that can cause significant adverse consequences — ranging from penalties and excise taxes to outright disqualification — or to consult with an experienced financial and tax adviser who can advise on how to steer clear of them.

This article does not focus on the draconian consequences of participating in what is commonly known as a “prohibited transaction,” [1] but rather on a far more common occurrence in which a taxpayer expecting a tax deferral on investment income in the case of an IRA, or tax elimination in the case of a Roth IRA, is confronted with the possibility that some or all of the income earned from a self-directed IRA investment will instead be subject to an immediate tax in the year it is earned. That can occur because of the treatment of the income generated by the IRA as unrelated business taxable income. In turn, the treatment of income as UBTI can subject the IRA to an unrelated business income tax. [2]

To view the full article, subscribers may click here.