At What Point Does UBIT Kick In For Leveraged LP Investments?

[Bryan Hancock]

Please don't respond to this with, "Ask an attorney or tax advisor." That is a given...I want to solicit comments prior to that.

Scenario: Form a LP to raise money for real estate transactions and structure it so that it is capable of investing in a number of distressed assets, including commercial and residential properties in bulk.

Question: When non-recourse debt is applied to leverage the LP funds invested the partnership could be considered a "business." At what point does UDTI come into play for this type of a venture? Is there a set of tests to determine whether or not the venture is suddenly "active" and thus subject to UDTI? Our goal is to give the LP investors leverage without UDTI or UDFI tax if possible. It is possible that certain types of activity could unravel the favorable tax treatment with a one-size-fits-all fund.

Investors: LP investors will be investing via a self-directed IRA entity and would ideally be able to take profits tax free. Investors could also be cash investors outside of a SDIRA entity, but the tax treatment here is clearer cut.

I have read articles on this and they are all very confusing to me. The main article I found seemed to have circular references, but it did do a decent job of highlighting the litmus tests from the author's perspective.

Does anyone know if there is case law on this and/or guidance from the IRS via a private letter ruling of sorts? I have read the IRS regs and they are far from helpful.