Using a SDIRA on a joint venture property with financing

[SHANELLE SHERLIN]

Hi all,

I am looking to set up a self-directed IRA with money transferred from a previous employer 401(k) to invest in a duplex in OK. The purchase price is $250K and I would be going in with a partner, likely by creating a new LLC. Exit strategy is a long-term hold and refinance in a few years. We would each fund about ~$30K for 20% down payment + closing costs.

I called 3 different self-directed IRA companies to get an idea of how to best structure the roll-over but I'm getting mixed information about how this would trigger the UDFI tax since I am leveraging someone else's $. One person told me that if I created a SDIRA, my profit would be taxed at 80% since we are only putting down 20% and someone else told me 50%, both of which are crazy high and make this deal not worth it. I was also instructed by one person to go the solo (401)k route as it will trigger UDFI but doesn't incur taxes, then someone else said that's incorrect.

Another thought I had was to serve as a private money lender thru my SDIRA and create a quit claim deed as a 50/50 tenants in common, but I’m told this still triggers UDFI?

I’d love some guidance and recommendations on this situation around what percentage of the profit would be taxed, how to best structure this deal if it makes sense, and if the UDFI tax can be written off.

Unfortunately, my CPA isn’t available to connect on this right now and I’ve been in contact with the seller over the past couple of days who is looking to move fast, so hoping the wonderful BiggerPockets community can provide some guidance.

I should also mention that I originally pitched a seller-finance deal as the owner owns the property out-right and I had read online that this could help avoid triggering a UBIT tax, but the seller wasn’t interested.

Really appreciate any help on this. Thanks so much.

[Brian Eastman]

@SHANELLE SHERLIN

Unrelated Debt-Financed Income is taxable to an IRA. UDFI is the percentage of income that an IRA receives as a result of non-IRA money in the deal.

In your case, the deal is 80% debt financed.

Your IRA is a 50% partner in the deal.

Therefore, 80% of the 50% share of income that your IRA receives is taxable UDFI.

Your IRA will then be able to use that same ratio - 80% of it's share of allowable deductions like depreciation, interest on the note, etc. The IRA is also provided a $1000 exemption.

The net tax will not be that big a deal. A few hundred dollars a year most likely. The gain on sale will also be taxed and that could be a bigger dollar number, but will not be a significant reduction in the net ROI for the deal.

The bottom line is that the IRA is receiving income due to the presence of non-IRA capital in the deal. That portion of income is taxable. However, the IRA is still receiving the benefits of leverage and a higher net cash-on-cash return than if it had engaged in the same transaction on an all cash basis.

The bigger issue is that this is a complex strategy that requires having a knowledgeable CPA on your team. You do not need to find an IRA specialist. They are few and far between. Any CPA who regularly works with non-profit and tax-exempt entities like churches and charities should be able to help you.

It may be more complex than a $30K investment merits.

Also.  The loan will need to be non-recourse.  Expect more like 40% down payment requirements.