UDFI Question (related to SDIRA)

[Mike Helminger]

I read through this post (and several others) and am trying to grapple with the idea of UDFI:
https://www.biggerpockets.com/...
Scrolling down a bit, Chris Wooten states the following in the comment section: 
I’m not a CPA. If the syndicator is strictly providing you returns based on a preferred share or percentage of buy-in, then the syndicator is
holding all of the leverage, and you would not need to concern yourself with UDFI/UBIT.

Is this true? For example, if I invest in a self storage syndication, with 70% LTV, and I have a fractional share and only receive net distributions from the fund (quarterly or at liquidation events), would UDFI not apply to an account held in a SDIRA?

[Mack Benson]

I'm not a CPA but this question is intriguing to me. Are you investing in a fund or directly into the LP side of a syndication? There may be differences if your SDIRA is investing in a fund of funds and I haven't looked into that at all so I'm curious what you come up with if that is the case. I have read into the UBIT through a SDIRA for investing in an LP and I do not know of any way to avoid it. Here are some notes I made during some previous research

• The income made through a SDIRA is subject to tax on the percentage of the gain that are attributed to the debt financing. Because most real estate is purchased with debt financing it is very common for SDIRA's to be subject to UBIT
• Example. Property is acquired with 70% debt financing then 70% of the gains will be taxed. It isn't as bad as it sounds due to depreciation.
• Typically SDIRAs cannot realize depreciation but they can when using debt financing on a purchase
• This makes it so the income is usually not taxed until the property is sold and gains are realized
• Even then the SDIRA is only required to file taxes if the is more than $1,000 of UBIT because the SDIRA is allowed a $1,000 deduction.
• UBIT is taxed at trust income tax rates.
• Example:
• Invest $50,000 through SDIRA
• Receive $50,000 of taxable gains
• Used debt to finance 70% of the purchase then 70% of the gains above $1,000 are taxed
• $50,000*70%=$35,000-$1,000=$34,000 in taxable gains
• Following the tax table this $34,000 is subject to a total of $10,088 of taxes
• You end up receiving $39,912 in gains from the sale net of UBIT.
• This tax would likely make a 12% IRR closer to an 11% IRR so it's about a 1-2% decrease in an IRR
• UBIT will impact most investments made through SDIRAs but this shouldn't deter people from using the SDIRA