SDIRA investing in MF syndication, who has paid UBIT?

Question

Of those who have invested in syndicated deals using their SDIRA/ROTH-SDIRA...

How many investors have successfully filed a tax return for their IRA to pay Unrelated Business Income Tax (UBIT)?

I see a lot of discussion around triggering the tax, and discussion around the merits of Solo 401k vs SDIRA, but looking for anyone that can shed light on their experience with paying UBIT.

Thanks,  Todd

Brian Eastman · Answer

@Lane Kawaoka

Your outline is not entirely correct.

Most syndications do not generate UBTI, only UDFI.

Just because a business entity such as a LLC or LLP is used does not classify income received from a syndication as "business income".  How the entity produces income is the determining factor.  If the entity produces passive income such as rentals or interest, then there is no generation of Unrelated Business Taxable Income.

If, however, the entity is engaging in a services business or something similar, perhaps hotels, self-storage, adult care, etc., then that produces trade or business income.  Generally speaking, trade or business income subject to UBIT is not favorable.  Such opportunities will not fit well within an IRA.

Most multifamily syndications do use debt financing as you indicate, and that does produce Unrelated Debt-Financed Income or UDFI which creates a UBIT obligation.

If a deal is 70% debt-financed:

• 70% of the gross income is considered taxable
• $1000 exemption off the top
• AND, something you omit - 70% of all your normal deductions such as interest on the debt, straight-line depreciation and other allowable expenses are applied as deductions.
• The end result is that a very small amount is then left as the net taxable income, and will often therefore fall into the 10% - 24% brackets - though the top rate is 37% as you indicate.

In most syndications with a $100K investment, an investor with an IRA will lose about 1% of the top-line return to taxation on UDFI and the necessary tax preparation over the life of the deal.  So, a deal that would produce 15% will net 14%.  That 14% is very likely much better net return to the IRA than a comparable non-leveraged deal with a similar balance of risk/reward.  As such, many investors with IRA funds choose to participate in multifamily syndications and are very happy with the stable and quality income such opportunities can provide.

Lane Kawaoka · Answer

@Todd Nurnberger[Note: From CPA and not this is NOT legal or professional advice]: When you invest in a business (syndicate = business) with your IRA, the IRA will be subject to UBIT (unrelated business income tax) and UDFI (unrelated debt financed income).

That said I would say most run of the mill CPA don't know what this is or would not think of it unless you the LP were explicit about it.

For our purposes, UDFI is produced when an IRA uses debt to purchase real estate. Essentially, the portion of the property’s income considered UDFI is based on the percentage of rental income derived from debt.

For example, Property A is purchased for $100,000. You put down 25% of the purchase price as a down payment and finance the remaining 75% with a traditional mortgage from the bank. The property produces $10,000 in net income for the year. $7,500 (75%) of the net income is considered UDFI and is subject to UBIT.

There is a deduction for the first $1,000 of income subject to UBIT. Income subject to UBIT over $1,000 is taxed at trust rates. For 2017, trust tax rates start at 15% and max out at 39.6% after just $12,400 of income subject to UBIT.

UBIT is paid by the IRA account. If for whatever reason UBIT is paid directly by the taxpayer, the amount paid is considered a contribution to the IRA.

I personally don't use a SDIRA for exactly these reason.

Brian Eastman · Answer

@Mike S.

A Solo 401(k) is not entirely exempt from UDFI, but does have a narrow exemption from tax on debt-financed income when the debt is used for the acquisition of real property.  In a properly structured syndication, this exemption will apply.

So yes, using a Solo 401(k) to invest in multifamily syndications is simpler than using an IRA - for those investors who legitimately qualify for a Solo 401(k).  We see a lot of folks trying to wedge themselves into a Solo 401(k) in order to save a few hundred dollars in taxes per year in an IRA and that does not make sense.

Justin Windham · Answer

@Mike S.

The Solo 401k is exempt from UDFI tax on leveraged real estate. While this can be an advantage over a self directed IRA, the exemption does not apply when other asset types are leveraged. Neither the Solo 401k nor the self directed IRA are exempt from UBIT in general. The Solo 401k's UDFI tax exemption on leveraged real estate tends to lead to quite a bit of confusion and over simplification from people thinking the Solo 401k is exempt from UBIT or UDFI tax in all instances.

Bernard Reisz · Answer

@Alina Trigub @Todd Nurnberger Glad to chime in here, but I actually did a podcast with @Taylor L. about this topic and many have found it helpful. There's great info on this thread already, and you'll find more than can be put in a BP post in the recording.

@Alina Trigub Honored by the mention. Thank you.

Alina Trigub · Answer

@Todd Nurnberger

@Brian Eastman did an excellent and detailed explanation of the potential UBIT hits for SDIRA's!

If you're looking for CPA's in the space, @Bernard Reisz happens to be in the SDIRA space and CPA at the same time. :)

Taylor L. · Answer

I'm in the middle of this right now. It's a pain in the butt to find someone who is qualified to do this who is also not prohibitively expensive. Remember that CPA filing costs also impact your return.

It's not an enormous tax, but it is something. It's more frustrating when sponsors or their CPAs take a long time to get K-1s out.

Bernard Reisz · Answer

@Todd Nurnberger Glad to share. It's at: https://www.passivewealthstrategy.com/self-directed-ira-myths-what-are-udfi-and-ubit-with-bernard-reisz/

Todd Nurnberger · Answer

@Bernard Reisz can you share which podcast you recommend?  When I googled your name  and podcast there were several listed. Thx

SDIRA investing in MF syndication, who has paid UBIT?

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