Unrelated Debt-Financed Income (UDFI)
Unrelated Debt-Financed Income (UDFI) tax applies to the portion of the property that has been debt-financed within a self-directed IRA.
When a self-directed IRA borrows funds to invest, this type of transaction causes the account to acquire what is called acquisition indebtedness—because, without debt-financing, your IRA would not have acquired the asset.
In this instance, any tax that may be owed is calculated based on the percentage of debt in comparison to the value of the investment property. For example, if your IRA purchases a piece of real estate by making a 40 percent down payment and obtaining a non-recourse loan for 60 percent of the purchase price, then, initially, 60 percent of the income received by the IRA would be subject to the UDFI tax.
To offset this tax, the IRA may also get to deduct a certain percentage of expenses, as well. It is important to note that the IRA, not you personally, is the entity responsible for paying any UDFI tax liability.
IRC 514 explains UDFI in great detail, but it is critical that you consult with your accountant or other tax professionals, as well, to ensure your IRA remains in compliance with IRS guidelines.