effect of UDFI on distributions

[David Mcginnis]

If my SIDRA (regular/untaxed contributions) pays UDFI tax, what happens to distributions from the IRA? Do I have to pay tax on that income again or do I now have basis in the IRA?

Also, I think I understand that bonus depreciation is not used for IRA tax calculations, and straight line depreciation is used instead. Do I have that right? Seems that matters a lot in a syndicated leveraged investment, because a low basis results in a high debt ratio, and can make most of the profits taxable. Also, I think there is a real possibility of taxable operating profit in the early years of a syndicated leveraged multi-family investment as compared to outside of an IRA you get substantial shelter from bonus depreciation. Does that seem right?

Also wondering if IRA's facing UDFI have to pay the ObamaCare surchage of 3.8% in addition to ordinary income tax, cap gains tax, and recapture tax?

I know I need to rely on professional tax advice. Just trying to get a basic understanding so I am in position to evaluate the advice of my CPA.

[Brian Eastman]

@David Mcginnis

IRA distributions are not changed based on the fact that an IRA may or may not have incurred tax on UDFI. All distributions are taxable from a tax-deferred account or tax-free on a Roth account based on standard IRS rules.

Think of the tax on UDFI as a cost for the IRA to be able to take advantage of the benefits of leverage. If the IRA contributes 40% of the cost of acquisition but receives 100% of the income produced from the investment, then 60% of that income flowing to the IRA is coming from the non-IRA money in the deal. That is what is being taxed.

The IRA is still going to receive the benefits of leverage and a higher cash-on-cash return. The boost in return that the leverage produces is dented a bit by tax on UDFI, but there should still be a net boost. A leveraged deal in an IRA will outperform a comparable all-cash deal in an IRA.

In my example where 60% of the income is taxable, the IRA gets to avail itself of the same 60% of normal deductions such as interest on the note, straight-line depreciation, etc. If there is still outstanding debt when a property is sold, prior depreciation is recaptured on the capital gain event.

Do not fall into the trap of comparing an IRA investment and tax treatment to a personal investment and tax treatment. They are always very different whether an IRA is invested in leveraged real estate or stock of a publicly traded company. The more productive exercise is to compare a leveraged syndication in an IRA to some other investment the IRA may make, and determine which will produce the best balance of risk and reward appropriate to your savings goals.

An IRA is not subject to the extra tax associated with the Affordable Care Act.

If your CPA is not familiar with this territory, seek out a professional who works with non-profit and tax-exempt entities.  The trust taxes that apply to IRAs apply to all such entities.