Solo 401k and the UBIT Rules

Solo 401k | UBIT | UBTI | Unrelated Business Taxable Income | Rules | MySolo401k.net

What is unrelated business taxable income?

• Tax sheltered accounts such as IRAs and Solo 401k generally don't pay taxes until distributions begin, ideally at retirement.
• Further, self-directed solo 401k can invest a variety of alternative investments such as real estate and businesses.
• Therefore, when you Open Solo 401k and invest in a business, you are in direct competition with businesses that pay taxes.
• Of course, this is unfair to tax-paying businesses outside retirement accounts including Solo 401k.
• As a result, to level the playing field the IRS requires Solo 401k plans that invest in a business to pay UBIT on net income generated from the investment in that business.

UBIT or UBTI Does Not Apply to Real Estate Solo 401k

• Unlike tax shelters such as IRAs that are subject to UBIT if debt financing (non-recourse loan or leveraging) is incorporate in the real estate transaction, Solo 401k, a type of qualified plan, is not subject to UBIT as it falls under the passive income umbrella.

•  However, investment types other than real estate that generate passive income include stocks, bonds, mutual funds, and money market accounts and thus subject the Solo 401k to UBIT if leveraging (margin) is incorporated.

 Don’t get confused; Investment in Trade or Business Subjects Solo 401k to UBIT

• Similar to IRAs, Solo 401k cannot escape paying UBIT from the investment in an operating business such as a partnership or LLC that generate pass-through income.

•  Instead, when a Solo 401k generates profits from a business, the net income is subject to payment of tax just like a business outside the Solo 401k to put it on the same playing field as the tax-paying entity that invested outside a solo 401k. For example, a Solo 401k that invests in a restaurant, an operating company, will be required to pay UBIT on the restaurant profits.

 Unrelated Business Income Tax Facts for Solo 401k

• Solo 401k real-estate purchases that incorporate debt financing are exempt from UBIT payment
• Solo 401k that incorporates debt financing when investing in an operating company such as a restaurant will be subject to UBIT on profits.
• UBIT does apply to Solo 401k investments in trade or business  that invests in a trade or business.
• UBIT is paid only on income of $1,000 or more from a trade or business
• UBIT is reported to the IRS on Form 990T, Exempt Organization Business Income Tax Return.
• UBIT falls under IRC Sec 511, and exceptions are found in Publication 598, Tax on Unrelated Business Income of Exempt Organizations.
• If UBIT applies, payment required with Solo 401k funds.