How UBIT and UDFI Taxes Impact IRA-Owned Real Estate with a Mortgage

Investing in real estate inside your IRA can be a great way to grow wealth in a tax-advantaged account.

Wait, what? Yes, you can purchase a real estate with your retirement account if you self-direct and your retirment account custodian allows it. 

And you can do so with a mortgage! But once you introduce leverage, meaning your IRA borrows money to help fund the investment...you’re entering the territory of UBIT and UDFI. And if you’re not careful, these taxes can surprise you.

In this blog, we’ll walk through what UBIT and UDFI are, how they’re calculated, what the 2025 and 2026 thresholds are, and how state taxes (especially in California) factor in. We’ll also cover why annual tax filing and basis tracking are critical, even when no tax is currently owed.

Let’s break it all down.

What Are UBIT and UDFI?

• UBIT stands for Unrelated Business Income Tax

• UDFI stands for Unrelated Debt-Financed Income

These taxes apply when your retirement account (like a Traditional IRA, Roth IRA, SEP, or SIMPLE IRA) earns income from a business activity or from an asset that is purchased using debt.

When your IRA invests in real estate with a non-recourse loan, which is the only kind of loan IRAs are allowed to use... the income generated from the debt-financed portion of the investment is considered UDFI and is subject to UBIT.

This only applies to the portion of income related to the debt. The cash-funded portion remains tax-deferred or tax-free (in a Roth), as usual. 

2025 and 2026 UBIT Tax Brackets

UBIT is taxed using trust tax rates, which escalate quickly:

Do these limits scare you? They should, you hit the 37% bracket quick and fast.  UBIT definitely doesn’t give you the generous brackets personal income does. The highest rate kicks in real quick.

NOTE if you invest in real estate with your business 401k, this doesn't apply. This only affects Individual Retirement Accounts (IRAs).

Example: $150K IRA with a $100K Loan

Let’s say your self-directed IRA purchases a $250,000 rental property.

• $150,000 comes from your IRA

• $100,000 is a non-recourse loan

• That means 40% of the property is debt-financed ($100k/$250k)

Now, let’s say the property generates $20,000 in net rental income in 2026.

• 40% of $20,000 = $8,000 is considered UDFI

• That $8,000 is subject to UBIT

• Note this net income, after depreciation. So many long term rentals don't hit net income, but short-term rentals can quickly.

Here’s how UBIT would break down (based on the brackets above):

• First $3,200 taxed at 10% = $320

• Remaining $4,800 taxed at 24% = $1,152

• Total UBIT owed = $1,472

That’s almost 7.5% of your total net rental income going out the door as tax.  

Of course, this is not factoring in the equity growth you are expecting from your real estate investment and only focused on the tax itself.

And frankly, not as huge of burden if you consider that you only put in $150k into this investment. 

We've had UBIT stop investors from considering these type of investments and that's not what we are here doing today.  At the end of the day, investing in real estate with leverage can be a powerful and smart wealth builder.  We just want you to be educated and know about a sneaky tax that you may not fully understand just yet.

How State Taxes (Especially California) Factor In

While UBIT is a federal tax, many states—including California—have their own rules.

In California, income from leveraged property held by an IRA can be subject to state income tax, even if no distributions are taken.

If your IRA owns property in California or earns UDFI from California sources, you could be required to:

• File a California Income Tax Return

• Pay California income tax

• File annual informational returns and possibly pay minimum franchise tax

And it doesn’t stop there. Even if you live outside of California, owning leveraged property in the state can trigger filing obligations for your IRA. 

Annual Filing Requirements: Even If You Owe Nothing

Here’s a common mistake: assuming you don’t need to file because depreciation or expenses offset your rental income.

Wrong.

If your IRA owns property with leverage, and there’s any UDFI, you may still need to file IRS Form 990-T—even if your deductions bring taxable income to zero.

Filing Form 990-T:

• Reports income and deductions

• Documents the calculation of UBIT

• Starts the clock on the statute of limitations for IRS review

Skipping it can create a mess later if the IRS audits you or if you sell the property and face UBIT on the gain. 

Why You Still Need a Tax Pro

Even if you think, “I don’t owe any tax this year,” that doesn’t mean you can skip planning.

A knowledgeable tax advisor will help you:

• Determine if UBIT or UDFI applies

• Allocate depreciation correctly between debt and equity portions

• File Form 990-T and applicable state returns

• Track carryforward UBIT losses

• Stay compliant year over year

And speaking of year-over-year…

Tracking Basis Every Year is Critical

Your IRA may be tax-advantaged, but that doesn’t mean basis tracking doesn’t matter.

When you use debt to buy property inside your IRA, it’s essential to track:

• Original purchase cost

• Improvements

• Depreciation

• Loan repayments

• Expenses and adjustments

Why? Because when you eventually sell the property, any gain attributable to the debt-financed portion of the investment will be subject to UBIT and the IRS will expect accurate basis calculations to support your return.

Without detailed records, your custodian or CPA will be guessing and you could overpay tax or get flagged for an audit.

Final Thoughts: Smart Planning Pays Off

Real estate inside an IRA can be a powerful wealth-building tool, especially now that more non-Wall Street investments are allowed. But if you’re using leverage, don’t ignore UBIT, UDFI, and the related tax filings.

Work with a qualified tax advisor who understands:

• IRA real estate investing

• Federal trust tax rules

• State tax rules, especially in California

• Annual reporting and basis tracking requirements

And if you’re looking for a trusted self-directed IRA custodian, check out Directed IRA .

This is your retirement. Make sure it works for you, not against you.