Depreciation within a Self Directed IRA
You are not able to use depreciation inside an IRA or a Solo 401K, unless the plan borrowed money for the investment.
If you have any other questions, please let me know,
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Carl
@Carl Fischer
Yes, I do plan on using leverage within the IRA, which is one of the main reasons I'm doing a Solo 401K. Why does borrowing factor into the equation of applying appreciation?
If you are not leveraging, then there is no tax paid within the IRA or 401k. As such, there is no need for deductions against that non-existent taxation, and depreciation does not apply.
When an IRA uses debt-financing, a tax known as UDFI applies to the percentage of the gains derived from the non-IRA (borrowed) money. Depreciation on the property factors into the UDFI calculations and will reduce the tax amount.
A Solo 401k is not subject to UDFI when debt financing is used to acquire real property. So, no tax, no need for depreciation.
Unrelated business Income Tax
The Unrelated Business Income Tax (UBIT) is assessed when a tax-exempt entity, such as an IRA or solo 401k plan, engages in a business activity that is not related to its general purpose. For example, if a self-directed solo 401k account is used to purchase a shoe store, the income generated from the business would be subject to UBIT. Reason being, selling shoes is no the general purpose of an solo 401k plan. This tax was created to keep tax-exempt entities on a level playing field with non-tax-exempt entities such as solo 401k plans and IRAs.
Unrelated Debt-Financed Income
Similar to the UBIT, there is a another tax called the Unrelated Debt-Financed Income () tax on IRA investment income derived from debt-financed property, proportionate to the debt on the property. HOWEVER, UDFI does not apply to solo 401k plans so this is why individuals prefer solo 401k plans over IRAs for investing in real estate whereby a none-recourse loan will be used.
No depreciation deduction is needed when there are no taxes. Some people choose to do more investments that they cannot otherwise find deductions for with their Solo 401k. For instance, many prefer to lend money with their Solo 401k plans and have a greater tendency to invest into direct ownership of real estate outside of the plan since depreciation can apply to those investments. All in all, there is quite a bit of flexibility to allow you to choose what works best for you.
@Carl Fischer I just sent you a message and a connection request.