Quote from @Michael Politi:
I am considering investing in a Preferred Equity Syndication. The pref equity would pay out a 7% (annualized) quarterly distribution and a 7% back end return when the pref equity capital is returned. The capital stack is approx 70% debt, 5% pref equity and 25% common equity. If I utilize qualified funds would this investment be subject to UBIT re UDFI? I know a common equity investment would be subject to UBIT but since there is no back end upside I wasn't sure if the pref equity would be viewed as a loan?
Hey Michael,
My understanding is in a preferred equity syndication, utilizing qualified funds such as those from an IRA or 401(k) can trigger Unrelated Business Income Tax (UBIT) when the investment generates Unrelated Debt-Financed Income (UDFI). UDFI typically arises when debt is used to acquire or improve income-producing property, and the proportion of income related to the debt can be subject to UBIT. In this case, since the capital stack includes 70% debt, it's likely that some portion of the income generated by the preferred equity investment could be attributable to UDFI, potentially triggering UBIT.
However, the preferred equity in your scenario may be treated differently from common equity, especially since there is no upside participation beyond the fixed return. Preferred equity is often structured to resemble a loan in that it provides fixed payments and a return of capital, rather than a share of profits, which could reduce its exposure to UBIT. The specific tax treatment would depend on how the preferred equity is structured in the syndication and whether it qualifies as debt-like equity or retains characteristics of a typical equity investment.
