UDFI (Unrelated Debt Financed Income) is not a bad and scary thing.
@Jon Holdman is correct about the steep tax curves. In 2014, the maximum tax bracket is 39.6% for any net income over $12,150. Investing in high yielding debt deals or operating businesses can create tax bills quickly if you don't pay attention. See Solo(k) rules for some UDFI exemptions.
While that tax rate above looks really ugly, the reality for most people results in minimal IRA taxation. As an example, say you NET $6,000 after depreciation and expenses on a rental property in your IRA with 65% debt-to-equity. Only 65% of that balance would be taxed ($3,900). First you deduct your $1,000 standard UBIT exemption. Now your IRA has $2,900 worth of taxable income. Anything under $2,500 is taxed at 15% (Follow Estate and Trust Brackets). The total tax due would be $475 and paid by the IRA. When you do the math, what is the effective tax rate?
Also note that if any losses occur during the first several years of operating your investment, those losses can be recorded and carried forward to offset future taxation.
As you pay down your loan balance, the debt ratio will reduce your overall exposure to UBIT as well. One common strategy is to accelerate debt reduction in an effect to avoid UBIT. It all depends of your risk tolerance and ability to finance new investments.
Using leverage in an IRA account is a rare occurance but should really be prized. Since personally guarantees are prohibited, very few (if any) brokerage accounts offer such leverage (margin) options for IRAs. Does leveraging your purchase power increase your ability to finance a more profitable property (or more properties)?
Assuming your real estate investments go as planned, you'll probably find that a leveraged real estate investment yields a higher rate of return than a non-leveraged deal in an IRA. Do the math and find out before you decide.
Check out my BiggerPockets blog for some additional commentary on UBIT.
