Whenever debt is used by a tax-deferred or tax-exempt entity (with some exceptions), tax is applied to that portion of the gain that is debt-financed. This income is called unrelated debt financed income or UDFI, which is a subset of UBTI. Taxes on both are calculated and reported on IRS form 990-T.

Any property held to produce income is debt-financed property if at any time during the tax year there was acquisition indebtedness outstanding for the property. When any property held for the production of income by a tax-exempt organization or IRA or Roth IRA is disposed of at a gain during the tax year, and there was acquisition indebtedness outstanding for that property at any time during the 12-month period before the date of disposition, the property is debt-financed property. In general, average acquisition indebtedness for any tax year is the average amount of the outstanding principal debt during the part of the tax year the property is held by the entity or IRA.

To calculate the average amount of acquisition debt, determine the amount of the outstanding principal debt on the first day of each calendar month during that part of the tax year that the organization holds the property. Add these amounts together, and divide the result by the total number of months during the tax year that the organization held the property.

The amount of gain or income taxable as UDFI for any tax year is the total income, multiplied by a fraction. The numerator is the average amount of acquisition debt, and the denominator is the average of the adjusted bases at the beginning and at the end of the year.

Before calculating the net income, certain deductions can be taken into consideration, just as they are when you purchase property outside of an IRA. To be directly connected with debt-financed property or income derived from it, the deduction must be clearly related to the property and its income.

Securities purchased on margin are considered debt-financed property.

Acquisition indebtedness is the outstanding amount of principal debt incurred by the organization to acquire or improve the property:

1. Before the property was acquired or improved, if the debt was incurred because of the acquisition or improvement of the property; or
   
   
2. After the property was acquired or improved, if the debt was incurred because of the acquisition or improvement, and the organization could reasonably foresee the need to incur the debt at the time the property was acquired or improved.