Unrelated Debt-Financed Income applies when an SDIRA obtains leverage from debt with a non-recourse loan. A Self-Directed Solo 401(k) is exempt from UDFI.
UDFI applies when gains are made related to debt.
This happens when a Self-Directed IRA obtains leverage from debt with a non-recourse loan. The percentage of income derived from the debt is subject to UDFI tax. UDFI tax rates are equal to the tax rates for Unrelated Business Income Tax (UBIT).
What should I know about UDFI?
Self-Directed Solo 401(k)s are exempt from UDFI tax given their status as tax-exempt trusts.
Self-Directed IRAs are not exempt and must pay UDFI tax.
UDFI applies to rental income and capital gains income from a debt-financed property (a purchase loan, improvement loan, or a non-recourse loan).
If you want to avoid it, you can not use debt with your property purchase.
You can read more about UBIT (UDFI is a type of UBIT) here.