Investor · Dallas, TX · Member since 2013 · 619 posts · 128 votes
If I plan to use funds in my Solo 401K to invest in a turnkey rental property (meaning a property that is rehabbed by a 3rd party, purchased by my 401K, and managed by a 3rd party) is that considered a "passive" investment thereby not incurring UBIT?
I've read differing opinions on this topic and would like an experienced hand to provide his/her opinion... paging @Steve Hamilton II or @Amanda Han :)
Bryan, you can use leverage for real estate acquisition transactions in a solo 401k and be safe from UDFI; however, inside an IRA is not a good idea.
This can all change however, if there is adequate room for depreciation to essentially zero out the income from the property. And yes depreciation is allowed.
Under IRC 514(a)(2), the deductions allowed with respect to each debt-financed property are determined by applying the debt/basis percentage to the sum of the deductions allowable.
The deductions allowable are those items allowed as deductions by chapter 1 of the Code which are directly connected with the debt-financed property or income therefrom (including the dividends received deductions allowed by IRC 243, 244, and 245) except that:
The allowable deductions are subject to the modifications provided by IRC 512(b) on computation of the unrelated business taxable income, and
The depreciation deduction under IRC 167 is computed only by use of the straight-line method. Reg. 1.514(a)
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
12y
I am using a SDIRA and all the legal advice I got sounds like you are on safe standing, assuming the 401K falls under the same rules. Although we feel we CAN do the management if we so chose according to the rules.
As to the comment above of 'dont do it' , I would not put a lot of wight into that. My tax guy is checking into the depreciation thing, (it is my first year, and his first SDIRA, but he has a good source for info on it).
BUT, even if you can not use the depreciation, I say 'so what'. In my case, not even figuring any Appreciation (which has historically been about 3-4% over 50 years here) we project about a 15%-18% return. Part of our goal was too diversify out of 100% stocks AND get better returns in the long run.
One reason we chose to do it within a SDIRA vs the 'normal' way is that we probably have 20 times as much funds in IRAs as we do liquid cash. The downside is that it is hard to borrow within a SDIRA (or 401K) so it is also harder to get the advantage of leveraging things.
I am using a SDIRA and all the legal advice I got sounds like you are on safe standing, assuming the 401K falls under the same rules. Although we feel we CAN do the management if we so chose according to the rules.
As to the comment above of 'dont do it' , I would not put a lot of wight into that. My tax guy is checking into the depreciation thing, (it is my first year, and his first SDIRA, but he has a good source for info on it).
BUT, even if you can not use the depreciation, I say 'so what'. In my case, not even figuring any Appreciation (which has historically been about 3-4% over 50 years here) we project about a 15%-18% return. Part of our goal was too diversify out of 100% stocks AND get better returns in the long run.
One reason we chose to do it within a SDIRA vs the 'normal' way is that we probably have 20 times as much funds in IRAs as we do liquid cash. The downside is that it is hard to borrow within a SDIRA (or 401K) so it is also harder to get the advantage of leveraging things.
Dan Dietz
Hey dan I like the way u talk.... no, u cant depreciate the house if bought in a sdria, hv no idea about this 401k mentioned above. We do partnerships in our sdria hence being able to write off a portion of the depreciation, if u even need to. I vote sdria or sdr401k all income is tax free. if this info helps u in any way pls vote for this post
If I plan to use funds in my Solo 401K to invest in a turnkey rental property (meaning a property that is rehabbed by a 3rd party, purchased by my 401K, and managed by a 3rd party) is that considered a "passive" investment thereby not incurring UBIT?
I've read differing opinions on this topic and would like an experienced hand to provide his/her opinion... paging @Steve Hamilton II or @Amanda Han :)
Yes, that would be passive. You are buying a rental property. Even if you bought a property that needed to be rehabbed, repaired it and then held it there would be no issue. The issue is buy, fix, sell.
Leverage however, can cause UDFI, in which case depreciation is allowed against that.
So leveraged real estate is a nice feature inside of an IRA.
Real Estate Consultant · Camarillo, CA · Member since 2010 · 2k+ posts · 1k+ votes
12y
@Steven Hamilton II My understanding is if an investor uses an SDIRA on a RE investment with 75% leverage, the profit from the leveraged portion would be taxed under UDFI. What I am hearing you say is that depreciation can be used to reduce some of that tax.
Bryan, you can use leverage for real estate acquisition transactions in a solo 401k and be safe from UDFI; however, inside an IRA is not a good idea.
This can all change however, if there is adequate room for depreciation to essentially zero out the income from the property. And yes depreciation is allowed.
Under IRC 514(a)(2), the deductions allowed with respect to each debt-financed property are determined by applying the debt/basis percentage to the sum of the deductions allowable.
The deductions allowable are those items allowed as deductions by chapter 1 of the Code which are directly connected with the debt-financed property or income therefrom (including the dividends received deductions allowed by IRC 243, 244, and 245) except that:
The allowable deductions are subject to the modifications provided by IRC 512(b) on computation of the unrelated business taxable income, and
The depreciation deduction under IRC 167 is computed only by use of the straight-line method. Reg. 1.514(a)
@Steven Hamilton IIgood point, leveraged real estate in Self Directed 401k is NOT subject to UBIT! This is just one of the benefits of the 401k over an IRA, among others are: Checkbook control, Roth sub-account allowing tax free investing, access to funds for personal needs via participant loan and some more.
Real Estate Investor · Sun Prairie, WI · Member since 2014 · 68 posts · 100 votes
12y
@Dmitriy Fomichenko
AT LAST! Someone with some sense. Thank you for this clarification.
401Ks do NOT incur UBIT with 3rd party financing. Your 401K can get a non-recourse loan from a bank or you can borrow money from a non-restricted 3rd party. You can leverage up to 100% of your property with no UBIT due if .....
IF there is NO SELLER involvement after the sale.
So if you acquire a property on land contract, you WILL have UBIT. But so what? If you get the property with no money down, you'll pay UBIT but YOU HAVE THE PROPERTY!
And your UBIT decreases over time.
And get this!
Are you ready for this?
You get to use your DEPRECIATION!!! Yes, your depreciation offsets UBIT!
So ultimately, you need to crunch the numbers. If the numbers shake out, then it's a good deal. Personally, I will incur UBIT all day long for a no-money down or lo-money down deal. If my 401K picks up a $100,000 property and I only have to put $5,000 down, with $2,000 per month rent, I'll have to pay UBIT. So what if I have to pay UBIT? I get to write off all my expenses PLUS depreciation.
If I pay off this house in 10 years, my UBIT decreases from 31.6% first year to 18.3% in year 5 to 1.7% in year 10. In any regard, I'd be getting a very large return on investment on my measly $5,000 even if my UBIT was 50%!
So thanks again Dmitriy for your excellent advice and knowledge. I have another rant about this "you'll lose your depreciation" nonsense, but I'll save that for another time. But for those of you who are interested, I'll GIVE you my depreciation just to be able to invest in real estate inside my 401K.
Millington, NJ · Member since 2013 · 37 posts · 7 votes
12y
If you are using the 401k for only the down payment then think about a pledged asset loan.
purchase the home, they would have to liquidate those assets for the down payment. What if you could offer the borrower a program where they could use their assets as collateral for the loan without having to liquidate? After all, if they liquidate their assets, they would be subject to a hefty capital gains tax, and, they would be pulling their assets out of an income bearing vehicle. We allow the borrower to "pledge" their assets in lieu of down payment (or LTV for a refinance). This way the borrower can keep their assets where they can continue to work for them. With Pledged Assets, we will lend up to $5,000,000 or more at 90% LTV with no mortgage insurance!
ADVANTAGES:
· Avoid capital gains tax – HUGE advantage – if the borrower liquidates stocks, bonds, mutual funds, etc., there is a big capital gains tax that can be avoided
· Assets continue to grow in an income bearing vehicle earning interest or dividends, and the account continues to benefit from investment growth. Also, the borrower may sweep profits as long as the portfolio value remains intact.
· Avoid “Gifts”…pledge instead…no gift letter required. Great alternative for wealthy relatives….
· Any person may pledge assets on behalf of borrower
· Refinances – instead of liquidating assets to pay down the mortgage so you can refinance, pledge assets instead.
· Complete flexibility to trade the assets…the borrower can continue to buy and sell stocks within the asset portfolio….
· Assets may remain at borrower’s own financial institution (BofI Lending would be added as a creditor/beneficiary) or they may be deposited into BOFI Federal Bank.
· Available on all scenarios; all products, occupancy types, property types, Interest Only, etc., and may be used in conjunction with Asset Depletion.
· 10% down with no Mortgage Insurance and loan amounts up to $5,000,000 or more….
· No charge to lock - $250 admin fee is the only cost of this program.
· Compensation is paid out based on the higher loan amount
Professional · Carlsbad, CA · Member since 2012 · 12k+ posts · 1k+ votes
11y
While UBIT does not apply to solo 401k real estate investments that incorporate debt financing, UBIT does apply to margin trading performed under the solo 401k brokerage account.
Hearne, TX · Member since 2014 · 68 posts · 20 votes
10y
I have a question about UBIT and SoloK. I have a SoloK set up with a LLC and Checkbook control. I just purchased a house with Subject-To. I am having the repairs done by a third part. Will turn around and owner finance. How does UBIT effect me and this deal?
UBIT would not apply to seller financing as it is virtually a note from the solo 401k to the buyer. UBIT generally does not apply to promissory note investments.
Hearne, TX · Member since 2014 · 68 posts · 20 votes
10y
Thanks Mark, But how does the existing mortgage that is part of the Subject-To apply to the UBIT. I still have to make payments on the existing note every month.
Real Estate Investor · New York City, NY · Member since 2015 · 5 posts · 0 votes
9y
Hi in reviewing this post, there seems to be some conflicting info within the post and also compared to what I've read outside the post. Is depreciation allowed for passive real estate investments within a sd-401k? When/if/how?
when you are investing in real estate using tax-deferred account you do not get to benefit from the depreciation deduction. What you do inside of the account does not affect your personal tax situation.
Pflugerville, TX · Member since 2015 · 20 posts · 10 votes
9y
Is Non-performing note investing too active for an SDIRA? I will select the note, the IRA acquires it and I manage various vendors towards a final resolution where the IRA either sells the now re-performing note or the property upon foreclosure. No intent to keep as a cash-flowing investment.
My gut is telling that this is too similar to a fix-and-flip business, but looking for some more experienced guidance.
That type of activity would most likely be subject to UBIT. Passive income not subject to UBIT includes rent from real property, interest, dividends and stocks. When the income is derived simply from buying and selling, especially if there is value added through the process, then that typically will be viewed as conducting a trade or business, and if done on a regular or repeated basis, would have UBIT exposure.
So it is not the notes, but the buy, remedy, resell model that create the exposure.
Professional · Lexington, MA · Member since 2016 · 136 posts · 43 votes
9y
@Ronald Lambert: I agree with @Brian Eastman on this... this is a subjective matter, which is based on both intent and actual.. If there is intent and even if have not done a as many fix and flips, then UBIT may apply. But if there is an actual fix and flip model (i.e. you have done many during the year), then UBIT probably will apply. But then UBIT may not apply on rental component of the income. Please work with an experienced and knowledgeable professional in this space to get it right.
Depreciation is a deduction used to offset taxable income. But Solo 401k is tax-deferred vehicle. If you buy a rental property with your Solo 401k the income produced by this property will be sheltered from taxes. The income is not taxable! So there is nothing to deduct the depreciation against.
In a self-directed IRA if you use leverage to acquire investment property then portion of the rental income will be subject to UBIT, that is when you can use the depreciation and other expenses to offset that income. But Solo 401k is exempt from taxes on leveraged real estate.