It is the afternoon of Saturday, April 7th and you are scrambling to get things done in uninterrupted silence. Your cell phone rings, it is not your wife/husband or kids so you ignore it. It rings again, you ignore it. Unannounced a client quietly walks into your office with a large envelope crammed full of paper and asks “Are you busy? I have my K-1s.” Trying to figure out how he got into your building, you of course smile and answer, “No.”
An hour later your client leaves you staring at several K-1s, some passive, some active, and one new one titled in the name of his IRA . Your client has just explained that he and an old friend created an LP that bought a farm in their IRA. He mentions that he was going to ask you about it, but was busy with the Final Four last year and forgot to mention it before the deal was done. Attached to the front of the K-1 is a letter with the phrase that warns, “If your investment was made through a IRA… you may be required to pay tax on Unrelated Business Income. Consult your trustee or tax advisor.”
I am certainly not a 990 expert and knew that every year I see more of these so I started searching for answers. I found on page 2 of the 990-T instructions that a fiduciary of an IRA may be required to file form 990-T if the IRA has net Unrelated Business Taxable Income (UBTI) in excess of $1,000. The fact that the fiduciary is required to file the 990-T leads to questions. Why isn’t the Fiduciary filing it? Why are they instructing the IRA owner to figure it out? Who should sign the return? For the most part this is handled through Letters of Instruction or Releases where the owner would direct the fiduciary to sign the prepared return, pay the tax and pay the preparation fee from IRA proceeds. Your client should consult with their fiduciary because the process can vary. Some fiduciaries, and I use that term loosely, have created their own “independent” approved agencies for preparing 990-Ts so they may not sign it unless their approved agency prepares it.
Unlike most 990s, Form 990-T for an IRA, SEP or SIMPLE is due the 15th day of the 4th month following the year-end. The due date can be automatically extended 3 months by filing form 8868. An additional 3 month extension can be applied for but is not automatic. The return should be filed using an EIN for the IRA, not the SSN of the owner or EIN of the fiduciary. If tax is due, estimated tax payments should be made through EFTPS using Form 990-W. The tax is calculated using the Trust Tables.
For the most part, as it relates to IRAs, Unrelated Business Income Tax (UBIT) can be imposed on income earned in an IRA on certain types of investments. Typical sources of income subject to this tax would be: (1) debt financed investments where non-recourse debt is used to finance the purchase of IRA assets that produce rental income, (2) an ongoing business, (3) gain on the sale of the two items mentioned previously.
Although many of the partnerships owned by IRAs, including some oil and pipeline partnerships, that I see do not have UBTI they may have Unrelated Business Losses indicated in Line 20 of the K-1 marked with a Code V or W. After netting with UBTI from other sources these losses can offset positive income. If net UBTI is a loss filing a 990-T may not be required but if these losses were put on the 990-T and elected to be carried forward they could be used to offset any future taxable UBTI. So depending on the situation it may be in our clients best interests to file the 990-T every year whether required or not.
With less faith in the stock market, relatively low returns in fixed income investments and growth in agricultural real estate values it seems that interest in owning this type of asset in an IRA is a question being asked more and more. The UBTI issue is just one added complexity and cost thrown into the decision of owning non-traditional investments in an IRA . This is a factor that our clients certainly need to be aware of before entering into these types of investments and our knowledge should add value to the service we provide or, at the least, mitigate risk.