Yes, it IS SUBJECT to UBIT.
The other issue I would be careful about is you cannot earn on the same transaction your IRA does. It could be argued you are doing an activity to personally benefit your IRA if your IRA does not take title to the property at any time.
You may want to reach out to me to discuss how your IRA and LLC Partnered because you may have engaged in a prohibited transaction already.
Great to hear (sarcasm)
Especially because my actions were based on equity trusts guidance. Thanks for the offer, I will be hashing this out with my cpa.
Also my SDIRA did take title as all my deals are a double close.
It sounds like You ran your Ira as a business thus UBITapplies. The houses were inventory you were selling.
Equity trust paperwork, as most custodians/administrators paperwork, probably says they do not give advice. We tell all our clients get advice from your professional-attorney, cpa, etc. they are the ones that you are having do your returns and provide advice. The UBIT is an easy call based on your description. You don't personally pay the UBITyour Ira does. If there wasn't UBIT everyone would run their business out of the IRA. I hope it is a Roth. It sounds like you made money so congratulations.
As @Steven Hamilton II suggested Make sure you are partnering with your IRA correctly so you don't have a prohibited transaction which may possibly have way higher costs than UBIT above.
If you want to discuss more PM me. Good luck.
If debt was used, then yes UDFI would apply.
@Dmitriy Fomichenko - I've talked David through the UBIT aspects on this, and I think he's ok on that aspect of it and understands all of that.
I think his main fear is the partnership structure of the partnership between he and his IRA and the possibility of it being considered a Prohibited Transaction. Can you offer some guidance as to some hazards and pitfalls of a partnership and how that might cause the transaction to be considered Prohibited? We can then hash out his partnership paperwork and see if there is anything to be worried about.
@George Blower This is a separate issue to having debt against properties in an IRA.
Wholesaling is operating a trade or business- which can't be done in an IRA. It's a tool for passive income. So it subjects to UBTI
The issue with partnering between an IRA and a disqualified party is that it is a gray area with a certain amount of risk. There are no specific guidelines from the IRS and not a lot of published case law on the topic.
There is an interpretation within the tax community surrounding self-directed retirement plans that a plan may joint venture with a disqualified party, so long as there are not any transactions between the parties. This might look like both parties entering into a transaction jointly on day one, setting the equity participation based on that initial funding and splitting all future expenses and income on that same basis.
However, the overarching principle here, and what is subject to the IRS looking at the facts and circumstances of a particular case, is that there may be no direct or indirect benefit between a plan and a disqualified party in either direction. This can be problematic in a lot of cases. Benefit could be things like:
Either party having access to a transaction that it could not execute on its own without the presence of the other party's funds. So a joint real estate purchase where an IRA and a disqualified party each bring between 40-60% of the equity might be OK, as either party could argue that mortgage financing would have been a means to do the deal on their own. But if one party brings 80% and the other only has the capital to bring 20%, could that 2nd party really have done the deal on a stand-alone basis? Probably not and there is risk in something like that.
Another example probably applies to Mr. Goings' situation. He has a personal business that gets out and actively markets to create wholesale opportunities. He then cherry picks deals that he wants to have his IRA participate in. His business could be viewed as providing a benefit to his plan both through the marketing efforts and by the ability to pick the best deals available. This latter would be a concern even if he is not joint venturing on deals - and if he were only cherry picking for the IRA deals that he is creating via his business networking and marketing.
Joint ventures and other types of partnerships are not entirely off the table, but extreme caution needs to be used.
Retirement accounts are designed to passively build wealth for retirement. As long as you invest your IRA funds in passive investments - all income and gains from such investments would be sheltered from taxation until distribution or in a case of a Roth IRA/Roth 401k - tax free.
Income and gains from investments that are not passive will be subject to UBIT, the IRA is responsible for paying this tax. Then at the time of distribution - account holder will be paying ordinary income tax. This is not very smart and cuts into your profit. In some instances if the returns are high - it might make sense, but generally speaking IRA should only invest in passive investments.
The second, and the most important question here is the fact that your LLC partnered with your IRA (both yourself and your LLC are considered to be "disqualified" in relation to your IRA). The IRS rules forbid and direct or indirect benefit to you from your retirement account. The IRS rules also forbid you from providing any services to your IRA. Once you get into the mix with your IRA - the burden is on you as the tax payer to prove you did not receive any personal benefits from the IRA and that the IRA did not benefit from you personally.
In your situation I think it's pretty obvious that your IRA gained some benefit as a result of your personal involvement. I don't think you will be able to stand under the scrutiny of the DOL or the IRS. My recommendation to you is to cease engaging in any transaction with your IRA, either personally or through your LLC, go hire an ERISA attorney who can take a closer look at your transactions and provide you with fiduciary advice.
Do not rely on the guidance you get from customer service rep. of your custodian, many of them are under-trained and ignorant of the rules. Plus they don't take any responsibility for what you do with your IRA. If you review your customer agreement you will find that waive any and all liability for any transactions in your IRA. The point is this - you personally must understand the prohibited transaction rules, and one of the basic ones is your involvement as disqualified person, and if something is unclear seek professional guidance.
Very interesting perspective and better to be safe than sorry. However, “Personal involvement” is tricky. If you buy a stock and bond trading software package, study it, and then use it for you personal accounts and your Ira to buy stocks and bonds is that “personal involvement”? If you take classes and build systems to help you to buy and sell stocks or anything else would that constitute “personal involvement “.
@Carl Fischer , I definitely agree with your approach "to be safe than sorry". But I don't think your example of using stock trading software would be equivalent in this compassion. Doing a real estate transaction together with your IRA is quite not the same.
I would rather err on the conservative side... If my understanding of a particular situation is incorrect - there is no harm to the IRA account holder. However, those who take liberal approach and recommend "Yes" concerning using IRA to partner with disqualified person may influence someone to commit a prohibited transaction which could wipe out entire IRA! Does it worth the risk???
After all, if someone get's audited - our opinions won't matter. The IRS will make the judgement call (or they will send it back to the DOL, who makes the rules). And I would not want to be in the position trying to argue with them. With self-directed IRA there are so many ways to put your retirement funds to work, do it 'clean', and make nice profits. I just don't understand people who have a self-directed IRA, have unlimited investment options available to them, but chose to invest in a 'grey area'.
Very well put. I agree -the SDIRA is to great a tool to muddy the waters when so many things can “clean”. Not many are IRAs are audited thus there is not much precedence- why introduce unnecessary risk.
While it is not prohibited to invest alongside your IRA or solo 401k for that matter, specific rules apply so it is important to consult with your tax professional before proceeding.
@George Blower , the problem is that most tax professionals do not fully understand this area either. Just yesterday I had a client forward an email to me from his CPA endorsing potential prohibited transaction. He was smart enough to continue his due diligence and asked for my opinion... And this happens a lot...
I strongly believe the every self-directed IRA investor should take some time to study and understand the basic rules in regards to prohibited transactions. They are not difficult to grasp. Most prohibited transactions arise as a result of "disqualified person's" involvement. So if the transactions is not an "arm's length" - they should stay away from it as far as possible. But if they want to pursue such transaction they should not rely on someone's opinion on public forum, or even their CPA opinion... Those are all valuable means in their due diligence process, but if they are headed into a 'grey area' they need something solid to stand on. That is when retaining an attorney who know's their stuff and can back them up I think is a must. But again, in most cases it's not worth the extra cost and effort when other safer options are available.
Natalie, you mentioned that you can't wholesale within an IRA, but I was given a sales pitch for a Solo 401(k) and they said that you can use the Solo 401(k) for wholesaling. The specific example given was that you could invest some money from your 401(k) into marketing, get a wholesale deal, and put the profits back into your 401(k). Is that true, or can you not wholesale with a Solo 401(k) either?
Were they talking about promissory note Imvestments?
be careful with those sales pitches... please re-read my comment above answering David's question. Retirement accounts are designed to be invested passively. Any gains, incomes and profits from an active trade or business in your IRA or 401k such as wholesaling will be subject to UBIT tax, which tops at almost 40%. IRA/401k will be responsible for paying this tax. Then you will have to pay ordinary income tax at the time of distribution. So it is not that you can't do it but the question is are you willing to pay that much in taxes?
Thanks for this discussion. The more I read about SDIRA, the more I realize that It could be a potential nightmare (paperwork, legal, profit, ...)... Not surprised, lots of banks don't loan to SDIRAs. I went through some of the banks on the lists posted on biggerpockets.com and some of their conditions are just very unfavorable compared to typical commercial loans. I was investigating them for a potential investment in multi family with 10+ units. All are non-recourse, of course (which is ok). But then some ask for things like: 60-50% LTV, very high rates (7-10%), some only do 3/1 arms, other only amortization to 15 years, other require to have x-amount of extra money left over in the IRA after the purchase, others wouldn't touch any multi-family with more than 4 units ... etc. The more I read about it, the more I realize it might not be what it is made to sound like... Just my 2 cents!!!
Everything you say is true. Using a self-directed IRA comes with certain limitations. Comparing using an IRA to invest in real estate to investing in real estate with personal funds, however, is an apples and oranges kind of comparison for the most part - the situations are just so different.
The best way to evaluate a self-directed IRA is as compared to other things you might do with the IRA account. If owning rental property or investing in private mortgages provides a better overall risk/reward situation than investing the IRA in conventional financial products, then there is a reason to pursue such a strategy.
As others have mentioned here, I've also experienced the frustration of getting a varying degree of different answers when it comes to the question of "wholesaling within your SDIRA?" As people have mentioned, there are sales pitches that promote it: I've heard from Equity Trust presentations that one can do it, not to mention also from known wholesaling figures like Vena. Perhaps the reps are not aware, and neither is Vena, that it's not something one should be doing? My CPA, like those of others who have commented, advised against doing it, while at the same time I've heard that as long as you're not running an entire business out of your account, and maybe doing one or two deals a year in it, you should be fine. I suppose it comes down to how likely you think your chance of being audited is, and your risk:reward threshold when considering possible UBIT?
For example, there is literature such as:
Or from people that are quite active in the business, like Seth:
Someone did follow up with a comment, stating:
His comment about no one really knowing the amount of deals the IRS would consider "running a business" is what I've gotten hung up on. I've heard from so many that it's such a grey area.
For you guys in this thread that clearly have a ton of knowledge and experience in this area, what are you thoughts on that?
The IRS rules state that when a tax-exempt entity (like an IRA) engages in a trade or business on a regular or repeated basis, then that entity is determined to be competing with tax-paying businesses and therefore subject to UBIT taxation.
The reason you see such a variety of opinions on the topic are twofold.
Firstly, there is no hard and fast rule stating that X number of such-and-such type transaction is going to cross the threshold of UBIT exposure. The IRS has broad flexibility using the facts and circumstances of a particular case to make a determination if the tax-exempt is substantially acting like a competing commercial enterprise. For someone who is not wholesaling personally, and using their IRA for a mix of passive activities as well as the occasional wholesale/flip transaction, the bar would be higher than for someone who is personally wholesaling 10 properties a year, and exclusively using their IRA for that purpose as well. The threshold could be 2/year or 4/year, but there is no set rule.
Secondly, many companies and real estate educators are simply interested in creating exciting sounding opportunities, and have no real concern about the tax code. Sad, but true. We see it all the time.
I would rely on the advice of your CPA.
Thanks for the reply- makes perfect sense! I can see how you'd be looked at with more scrutiny if you're a full time wholesaler who on the side only wholesales within their SDIRA, as opposed to someone who might have a 9-5, and buys stocks, private lends, and the occasionally wholesales a deal here and there within their account.
Given that there is no hard rule, like you mentioned, it seems that it would be a matter of personal comfort with the risk involved, driven to a large degree by your particular situation as well (i.e. wholesaler vs not). Perhaps a person wholesaling full time wants to invest in equities with the money in their Roth, and chooses to grow it by doing just one or two deals a year in the account, and is ok in assuming the risks of doing so. I'm personally on the conservative side, and agree with you that the CPA's opinion should be held to a high regard.
Thanks so much for your response, Brian!
@Louise Alexander a little bit of what we were chatting about.... :)
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