Rental Property Investor · Boerne, TX · Member since 2015 · 94 posts · 52 votes
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.
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.
Rental Property Investor · Honolulu, HAWAII (HI) · Member since 2011 · 4k+ posts · 2k+ votes
6y
@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.
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.
Rental Property Investor · RVA · Member since 2016 · 5k+ posts · 4k+ votes
6y
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.
Rental Property Investor · Boerne, TX · Member since 2015 · 94 posts · 52 votes
6y
@Brian Eastman @Lane Kawaoka. Thanks you for sharing the detailed posts. I am comfortable with the concepts that you both described and Brian outlined the situation I am facing very well.
In 2019 I had a syndicated Multifamily deal I had invested in come full circle and this is the first year the K1 did not show a loss.
As you mentioned most CPA’s don’t make EBIT filings often and can be a bit unsure about the filing process. I am hoping to connect with a live person that has been through the process- gotten an EIN number for their SDIRA, filled the form 990-T and sent it to their custodian for signature and to pay the tax due from the SDIRA.
CPA delivering RE Tax Tools: 1031 Exchange, SDIRA, 401(k), Cost Seg · New York City, NY · Member since 2017 · 581 posts · 563 votes
6y
@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.
Contractor · Sheboygan, WI · Member since 2016 · 921 posts · 266 votes
6y
@Todd Nurnberger beware of syndications. In 25 years of experience I have yet to see more than a 6-8% yearly cash flow from RE apartment investing. UDFI in an IRA is indeed to be avoided because of high trust tax rates rather quickly.
Investor · Los Angeles, CA · Member since 2015 · 38 posts · 6 votes
5y
How about using Solo 401k, which is exempt from udfi. Does that mean it is also exempt from ubit if investing in a multifamily syndication as a limited partner?
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.
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.
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.