UDFI Difference in Loan vs Partnership?

Question

Hello All,

I have been using SDIRA and SOLO401Ks for some time and understand when *I* have to pay taxes related to borrowing money.

Where I have a questions now is that I have a potential 'investor' who might be interested investing in buy-n-hold properties with me by either;

1) lending me the down payment portion from their SDIRA at a set interest rate and term which I would use to take out a portfolio loan (20% down). They would not get any profits other than the predetermined interest rate.

OR

2) 'Partner' with me by putting up the down-payment towards a portfolio loan (20% down) using funds from their SDIRA without a 'set rate' of return and we would split the profits in some way.

Our preference would be option #2 most likely.

I am having a hard time wrapping my head around how the taxes UDFI taxes would  work in option #2. Say if we partnered on a 100K property using their SDIRA funds as a 20K (%) down payment, and borrowed 80K and were 50/50 partners. I am thinking this would be in an LLC with each of us being 50% partners. What would be the effect on either of us as far as UDFI taxation goes?

Thanks, Dan Dietz

Daniel Dietz · Answer

Good morning all,

Do any of you have thoughts on whether it would be a 'prohibited transaction' for my potential partner to be a 50% partner in the LLC, while contributing the 20% down-payment? It 'seems' like it would be but Im not quite sure.

Is there a way where a partner could be only a 20% partner in the LLC by using their SDIRA funds for the needed down-payment, and myself be an 80% owner by obtaining financing, but we split the profits '50-50'? That is assuming of course that our lender would allow it.

I have several different potential partners to do deals in this manner so want to figure out a 'blue print for it up front'. The goals would be for their SDIRA funds to go as far as possible in the amount of rentals acquired and for me to not use up my capital but instead contribute the time and expertise to find, acquire, and operate them in the most profitable manner possible.

Thanks, Dan Dietz

Nicole Bernshaw · Answer

UDFI tax is levied only on the percentage of the profit generated by the amount leveraged (that is, outside SDRA amounts) after all expenses have been subtracted (that is, net profit).

Naturally, make sure that your investment "partner" is not a prohibited person.

Daniel Dietz · Answer

@Brian Eastman thanks for the explanation of how the UDFI would work.... makes sense how you laid it out.

@Dmitriy Fomichenko we would be buying it (more than one over time) in a newly formed LLC. The plan would be to use conventional portfolio loans that require 20% down. The partner's SDIRA would be contributing the whole down payment (20%) and I would be doing all the work of finding the deals, all business side of things to get the property in service, property management etc...... We are thinking a 50-50 split of profits.

One of the things I was not sure of is how it would work on his side. I am wondering if he is 50% owner of the LLC, would his SDIRA be able to make the down payment, or would that be a 'prohibited transaction', which I think I have also heard called 'self dealing'?

@Travis Sperr, it is a lender that I have done portfolio loans with before. He is OK with the loans either being contributed 100% be a partner, or if I were to borrow the down payment (for example from my friends  SDIRA) that is OK too, as long as ALL debt stay at a 1.2 DSCR or better.

Thanks, Dan Dietz

Dmitriy Fomichenko · Answer

Dan, just want to make sure I understand what you are trying to do... are you considering buying this investment personally (not in your retirement account) and using a partner (unrelated person's IRA) to provide the capital?

Brian Eastman · Answer

@Daniel Dietz

In your scenario #2, the income received by the IRA would be 80% debt financed.  The fact that the LLC distributes income in a different ratio than the member contributions does not change that.

So, for the IRA holder's 50% of the income, 80% of that is looked at by UDFI.  They will then apply 80% of the normal deductions such as depreciation on the property, interest on the note, etc. to reduce the net taxable amount.

Your CPA can help you with the precise calculations for that investor.

Jessica Zolotorofe · Answer

@Dmitriy Fomichenko - can you weigh in?

Travis Sperr · Answer

@Daniel Dietz not following 100%  - in either case, is the borrower or property titled in the self-directed account?

just a few ideas-

if titled in the SD account - it needs to be non-recourse and I typically see 65% LTV on those loans.

If not titled in the SD account, the lender likely won't like the equity being borrowed or coming from a source other than your assets.

It is almost always less expensive to borrow the money than a partner, although if the partner is putting up all of the money, you are doing well for no cash into the deal. Lots of nuances in partnering that create more headache than it is often worth.