Endowments, foundations, pension plans and IRAs are tax-exempt — but only on investment income. If they earn money from running a business (or from a fund that runs one), that's UBTI and it's taxed.
The trap most people miss is the debt rule. Income from property bought with borrowed money is UDFI (unrelated debt-financed income), and the borrowed share of it counts as UBTI even if it's “just” rent or dividends. Leveraged real estate funds are the classic case. Some exempts — qualified pension trusts and educational institutions — can escape UDFI on real estate if the fund meets a set of conditions known as the “fractions rule.” Everyone else uses a blocker or avoids leverage.
Worked example
A private foundation invests in a fund that buys a $10m building with a $6m mortgage. The building nets $1m of rent. Because the debt is 60% of the building's basis, roughly 60% of the income — $600k — is UDFI, taxable to the foundation (after a $1,000 specific deduction) and reported on Form 990-T.
Where you'll see it: LPA covenants to “use commercially reasonable efforts to avoid UBTI”, subscription-line borrowing debates, and Form 990-T.
Full explainer: UBTI for fund investors →
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This glossary is general information, simplified for learning. It is not tax, legal or investment advice, and real structures turn on facts and documents not shown here.