SDIRAs, UDFI and UBIT

[Daniel Cruz]

Hi All,

I am researching buying rental property w/ a SDIRA. And after talking to a SDIRA custodian, she schooled me on non-recourse loans and the taxes associated w/ purchasing leveraged property.

So I am wondering is there a way to avoid the UDFI taxes short of purchasing the rental free and clear? If I create a LLC and the IRA invests in the LLC, then if the LLC buys rental property can the UDFI taxes be avoided?

Also in the long run, is it more beneficial to buy the rental free and clear or to just pay the tax?

One more thing, is UDFI similar to UBIT? What’s the dif?

I know you may not be an accountant – I promise not to sue. :-)

Thanks for your time…

[David Beard]

You can't use a straw buyer (the LLC) to avoid UDFI.

You can transfer your SDIRA into a SD401K, as that latter type of account does not incur UDFI when it borrows. You just need a tiny business of some sort to "sponsor" the account, very easy to set up.

Note that depreciation can be taken against the income when computing UDFI in your SDIRA, so combined with the loan interest and other expenses, you could end up with little taxable income, thus making the tax less of an issue. And it helps to be more aggressive with depreciation (i.e. separately write off appliances/carpeting/floating floors/cabinetry as 5 yr property, and driveways/sidewalks/fences/landscaping as 15 yr property).

However, be aware that UDFI and UBI is taxed using the estate/trust tax rates, very nasty, they get to 39.6% pretty quickly (see below):

If Taxable Income Is:	The Tax Is:
Not over $2,500	15% of the taxable income
Over $2,500 but not over $5,800	$375 plus 25% of the excess over $2,500
Over $5,800 but not over $8,900	$1,200 plus 28% of the excess over $5,800
Over $8,900 but not over $12,150	$2,068 plus 33% of the excess over $8,900
Over $12,150	$3,140.50 plus 39.6% of the excess over $12,150

UDFI is when you borrow in a SDIRA, UBIT is when you engage in an active business in your SDIRA or SD401K (such as flipping, wholesaling, and building/development). However, if your account is primarily holding passive investments (notes, loans, rentals), then you can typically get away with 1 or 2 flips/wholesales a year without worrying about the UBIT.