Stocks and UDFI (Unrelated Debt Financed Income)
By Alisha Bennett
Recently, we’ve had a few questions about Unrelated Debt Financed Income (UDFI) and how it might apply to investments in the Check Book IRA structure.
Oh yes, UDFI, that four letter “word” that can sneak up on your retirement plan and carve off a bit of your funds for Uncle Sam.
If you aren’t familiar with UDFI (Unrelated Debt Financed Income) in regards to an IRA-LLC; it’s essentially a tax on money that the IRA-LLC borrows (since the IRA-LLC is benefitting from funds that are not its own or are “unrelated”).
So logically, if the IRA-LLC purchases real estate and borrows a portion of the purchase price; UDFI will come into play.
But, there are a few other situations in which UDFI could apply; such as leveraged trading/options in the stock market or investing in a real estate LLP that then uses leveraged purchasing.
The code defines a transaction subject to the UDFI tax, as a transaction where there is “acquisition indebtedness” (see https://www.law.cornell.edu/uscode/text/26/514). It doesn’t really matter where the leverage is worked in, its a wide enough term that it would apply to any situation where leverage or a loan of some kind is used.
So, make sure to calculate UDFI into your investment strategy if you intend to borrow funds to purchase real estate or dabble in the stock market. If you’re not sure if UDFI would apply to your particular investment it’s best to contact your CPA to discuss.
Or better yet, review the Solo 401K to see if it’s a good option for you. Solo 401Ks are exempt from UDFI when it comes to property purchases.