If you’re using retirement money to invest in a real estate deal, chances are you’re doing it through a self-directed IRA. One thing we always talk to our self-directed IRA investors about is UDFI.
You may have never heard of UDFI. A lot of investors haven’t, and that’s ok.
But because real estate deals can involve debt, UDFI can potentially affect the taxes of income earned inside your IRA.
We’re telling you this for the same reason we talk openly about timelines, returns, risks, and exit strategies. We want you to understand what you’re investing in and know what questions to ask before your money goes anywhere.
Please keep in mind, we’re not tax professionals. And we’re not going to tell you whether you should invest through an IRA, use another account, or make a different investment decision. But we are going to tell you UDFI exists, so you can take that question to someone who can advise you.
So, What Is UDFI?
UDFI stands for Unrelated Debt-Financed Income. Essentially, if you use an IRA to invest in real estate, you may be taxed on the returns you make.
It comes into play when an IRA tax-advantaged account invests in an income-producing property that involves debt (e.g., a bank loan). In that case, a portion of the income attributable to the debt may be treated as unrelated debt-financed income and you may be taxed on that.
The amount taxed depends on a lot of factors, including how much debt is involved, the income generated by the investment, applicable deductions, and other tax rules.
And investing with us doesn’t automatically mean you will owe UDFI. Not every project uses debt, not every investor uses an IRA, and whether UDFI applies depends on the specific investment and account.
It’s a whole tax “if this, then that” situation, which is exactly why this is something to take to a CPA or tax professional who understands self-directed retirement accounts. So, we won’t get too nitty-gritty here.
You don’t need to become a tax expert in any of these acronyms. You just need to know enough to ask a tax professional.
Why Are We Telling Blueprint Investors About It?
Because we develop real estate, and our projects may include bank financing. We also hate surprises, so we want you to be aware.
It’s really that simple.
Does UDFI Mean You Shouldn’t Use Your IRA?
No, not necessarily. Learning that a potential tax exists doesn’t automatically mean you’re subject to it. It also doesn’t tell you whether an investment is worth it, or whether an IRA is the right or wrong way to fund it.
All it means is you need to do your due diligence (something we also talk about here) before you invest. And we don’t mind sharing the questions we’d want you asking before you invest, either.
Ask These UDFI Questions Before You Invest:
- Could this investment create UDFI for my self-directed IRA?
- Based on the amount I’m considering investing, what could the potential UBIT look like?
- Are there deductions, account rules, or other factors that could change that calculation?
- After accounting for the potential tax, does this investment still make sense for what I’m trying to do?
And while you’re asking your tax pro these questions, give them all the deal details they need to answer those questions. Give them our deal documents. We don’t mind.
That’s going to help them give a more accurate answer than trying to guess based on something you read in a Google search or heard from another investor whose tax situation may look completely different from yours.
A Tax Doesn’t Automatically Make an Investment a Bad Investment
Taxes are already part of investing. UDFI is just one more tax rule that can come into play when you’re investing through an IRA.
That’s why they have that saying “the only thing guaranteed in life is death and taxes.” And they weren’t lying!
The important thing to consider is how it affects you, because it’s easy to hear:
“Wait, I could owe tax inside my IRA?” and immediately assume that means you should avoid the investment.
But the existence of a tax by itself doesn’t tell you whether the numbers still work. The better question is what the investment looks like after you account for it.
If your tax professional calculates the potential UBIT and you’re still comfortable with the projected return, you may decide the investment makes sense for you.
If the tax changes the numbers enough that you’re no longer comfortable with the investment, then that opportunity isn’t right for you. There will be other opportunities with us and with others. Either way, you made the decision with the information in front of you.
That’s what we want.
We’d Rather You Know Before You Invest
We talk a lot about knowing where your money is going and understanding how the deal works. That awareness doesn’t stop once the money’s in your hand.
It includes knowing the fees on every account you have, knowing the risk, and knowing the tax questions that could affect what you ultimately keep.
So if you’re considering using an IRA to invest in one of our real estate projects, ask your CPA or tax professional about UDFI before you invest.
We can explain the deal and provide the information they need. They can help you understand how the tax rules apply to your account and your situation.
Then you can make the decision for yourself with the full picture in front of you.
