“You open a self-directed IRA and buy a rental with a mortgage. What’s the tax bill you weren’t expecting?”
UDFI tax is the bill most investors don’t see coming when their self-directed IRA buys a rental with a mortgage, and yes, a Roth IRA can owe it too. In our September live Q&A, guest John Bowens of Equity Trust Company walked through a real client’s leveraged fourplex, what the tax costs every year, and the move that could take it to zero at sale.
Quick answer: When an IRA buys real estate with debt (directly, or as an investor in a leveraged syndication), the share of the profit financed by the loan is unrelated debt-financed income (UDFI). It’s taxed inside the IRA, reported on Form 990-T, at rates that can reach 37%, and every kind of IRA can owe it, Roth included. A self-directed Solo 401(k) generally doesn’t owe it on debt used to buy or improve real estate, so pick the account before you buy.
John’s client bought a fourplex in his traditional IRA about five years ago for roughly $500,000. Today it’s worth about $667,000, brings in about $72,000 a year in gross rent, and carries a non-recourse loan (the only practical kind for an IRA). It’s about 60% debt-financed, which the IRS measures against the property’s adjusted basis, not its market value. A good investment. But because there’s debt on it, his IRA is exposed to a tax most IRA owners have never heard of.
UDFI isn’t charged on all of the property’s net income, only on the percentage financed by debt. At 60% leverage, 60% of the net income is exposed. Depreciation on the building offsets most of it, so for 2025 he owed only about $200 of tax. Small, but he still has to file a Form 990-T for the IRA, and paying someone about $500 to prepare it means he’s spending roughly $700 a year more than he needs to.
A common assumption is that a Roth IRA is immune because it’s tax-free. It isn’t. Traditional, Roth, SEP and SIMPLE IRAs (and HSAs) can all owe UDFI. It also applies when your IRA is a limited partner in a real estate syndication and the apartment building inside the deal has a mortgage. That doesn’t mean you should walk away from the deal; it means you should run the numbers and check whether a different account is the better home for it.
When the client called asking how to get around the 990-T, John asked a few questions. Are you self-employed? Yes — a private physician with no W-2 employees and no plans to hire any. Have you heard of a self-directed Solo 401(k)? Not really, but he already had an individual 401(k) at a big brokerage. That was enough: the plan was moved to a self-directed Solo 401(k), and the fourplex is being rolled over from his traditional IRA into it.
The reason is a specific exclusion in the tax code (Section 514): qualified retirement plans such as a Solo 401(k) generally aren’t subject to UDFI on debt used to acquire or improve real property, as long as the plan meets the conditions. The yearly saving here is modest: about $200 of tax and a $500 filing. The real money is at sale. He has about $100,000 of gain in the property. In the IRA, John’s rough estimate is $100,000 × 60% leverage × a 20% long-term rate ≈ $12,000 of tax (a full calculation would also pick up depreciation recapture, taxed at up to 25%). In the Solo 401(k): generally zero.
Laura’s summary: inside an IRA, tax on a leveraged rental can climb as high as 37% quickly on the 990-T, and investors get caught when the IRA doesn’t have enough cash to pay the bill and they can’t contribute more that year. The same rental in a self-directed Solo 401(k) can owe nothing.
One more check: if you’re investing in a leveraged syndication through a Solo 401(k), ask the sponsor whether the deal meets the extra partnership requirements for the exclusion (Section 514(c)(9)).
Official IRS reference: IRS — Publication 598, Tax on Unrelated Business Income of Exempt Organizations
Yes. UDFI applies to traditional, Roth, SEP and SIMPLE IRAs and HSAs when they earn income from debt-financed property.
Roughly, the share of net income (and of the gain at sale) that matches the property’s debt percentage is taxable, after allowable expenses and depreciation, and reported on Form 990-T.
Generally yes, for debt used to acquire or improve real property, provided the plan meets the conditions of the tax-code exclusion. IRAs don’t get that exclusion.
Self-employed people and business owners with no employees other than themselves and a spouse. Part-timers can become eligible, so check before you hire.
These answers come from our monthly open Q&A. Only newsletter members get the invite (real tax strategy for business owners, twice a week, no fluff).
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Guest: John Bowens, Director & Head of Education and Investor Success at Equity Trust Company, appeared as a guest. Custodians, including Equity Trust Company, do not provide tax, legal or investment advice.
Disclaimer: This article is for educational purposes only and is not tax, legal, or financial advice. Every situation is different. Talk to a qualified professional about your specific facts before making any decisions.
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