Note Investor · Pasadena, CA · Member since 2009 · 849 posts · 544 votes
15y
You can buy good paper for 18% - you just need to find a motivated seller, just like buying real property.
I always try to structure the deal where the WORST case scenario is that I get paid off with the monthly payments. If I buy right (ITV of 60% or less), the BEST case scenario is that they stop making payments.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
For those all caught up in trying to figure out WTF the IRS cares about you should read the following article from APS's 2009 Q2 newsletter:
Unrelated Business Income Tax by David Hanick
The article is an excellent primer on the subject and at the end it cites Hanick's contact information. I actually called him when we were setting up a precursor to our current fund to get some advice on this because we wanted our LPs to be able to invest with their IRA funds and not be subject to constraints like they would if they invested individually. He was quite knowledgeable from what I remember.
As you can see from the article things are not straightforward. These types of income are excluded from UDTI:
Investor · Fort Wayne, IN · Member since 2009 · 391 posts · 257 votes
15y
Bryan wrote:
"You aren't going to get clear-cut answers to these issues. At the end of the day you have to be able to defend your position in court so make your transaction more "passive" if you intend to try to avoid some of these taxes. Our tax system is so freaking stupid!"
Well: now there is a statement we can probably all rally around especially the last one.
Now that we have agreed to disagree on this UBIT: I am meeting with my CPA next week to discuss the issue.
My evaluation will begin with the assumption that if I flip houses in my IRA, I need to be prepared to pay the UBIT.
With that said, I will now analyze the numbers and detrmine if my best return is to flip houses with my SD-IRA even though I might be paying the UBIT.
I will then cross reference that return against other options that do not trigger the UBIT such as holding rental property.
If there is one conclusion that I have come to after 30+ yrs of investing experience is that no one cares about my money and return as much as I do. Therefore, I want to have control of the situation as opposed to giving it to a Money manager, mutual fund manager, or a CEO of a publicly traded company.
Jon, thanks for starting this thread. This has been an educational and beneficial discussion for me as I am on the brink of making the decision to convert my Roth to an SD-IRA.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
I think all of the focus on UBIT is really the tail wagging the dog. If you need those funds to execute the project then who cares if you have to pay a little bit of tax to get it done? The goal should be maximum after-tax profits and NOT (!!!) minimum taxes. If things are iffy I would err on the side of paying the tax personally…especially if your CPA tells you it will expose ALL of your SDIRA funds to trust tax rates if you lose the argument in court.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
Originally posted by Bryan Hancock:
Once debt is employed UDFI kicks in unless you have an exception. 401(k) plans offer this exception as has been mentioned across some threads
The other exception is if you pay off the debt 365 days prior to selling the property. That also eliminates the tax. Also keep in mind that we were discussing UBIT and UDFI (unrelated debt financing income) occurs when leverage is used inside the IRA. Although they both trigger the tax, they are both not the same thing.
Originally posted by Jake Kucheck:
What you don't address though is how note arbitrage is considered a business. To me, that's a lot more akin to buying a stock that goes up in market value and selling it for a profit than it is flipping a house.
Jake, I don't recall this question coming up in this thread but I did address it in another. I agree 100% with you. Trading/buying/flipping notes (paper) is much more like stock trades and although I am not 100% sure, my 99.9% guess is that such investments would NOT be subject to UBIT inside an IRA. I intend to get clarification on this in the near future.
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
15y
This is where there could be substantial opportunity. You are buying and selling debt, like bonds, except the secondary private mortgage market is inefficient compared to the bond or stock market. What if you could make several percentage points per round trip transaction, turn your money over several times a years, and do it tax free or tax deferred? Anyone want to admit to doing something like this?
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
Jon, I have not done it, but if UBIT is not applicable, then I would definately be interested. If UBIT was applicable, I may still do it if the numbres work out favorable compared to doing it outside an IRA/401k
Investor · Kalamazoo, MI · Member since 2009 · 1k+ posts · 495 votes
15y
We work with several investors that use IRA funds to buy notes with. I like to set this up as a business loan from the IRA to my company. We use the money to fund our note purchase and the note itself as security for the loan. We plug this into loan servicing using a third party to manage collections and payment splits. Since the IRA is just making a loan and not actually engaged in the business, I don't think our IRA money partners are subject to UBIT.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
Originally posted by Marc Faulkner:
We work with several investors that use IRA funds to buy notes with. I like to set this up as a business loan from the IRA to my company. We use the money to fund our note purchase and the note itself as security for the loan. We plug this into loan servicing using a third party to manage collections and payment splits. Since the IRA is just making a loan and not actually engaged in the business, I don't think our IRA money partners are subject to UBIT.
In that scenario, you would be correct Marc. But in a scenario where your investors who use IRA funds bought, then sold the notes without you, would that incur UBIT or not, I think not, but until it is clarified, question remains.
Investor · Kalamazoo, MI · Member since 2009 · 1k+ posts · 495 votes
15y
I am a long ways off from a tax adviser but, I think I know where to go for a qualified answers and will try to prompt some responses here.
My gut feeling is that if your IRA is to buy a performing note with the intention of keeping the note for long term income, then there would not be a tax liability as the payments collected on the note are treated as regular income. If there is a problem with the note and you have to foreclose at some time down the road you would just hire a professional to handle the business end of things.
Buying a non performing note would be a whole other can of worms but, it could still be done passively with the right people in place. I think most of the issues would arise out of being to hands on. I like the idea of staying as hands off as possible so I don't chase to many non performing notes. I will see what and who I can dig up regarding the real deal.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
To me buying notes with the intent to hold them is the equivalent of buying securities at a "discount" using your SDIRA. I'm not sure why the rules would change.
If you have to seize the collateral then just make sure you use a property manager. This seems much clearer cut than an intended fix/hold that turns into a fix/flip.
Investor · Kalamazoo, MI · Member since 2009 · 1k+ posts · 495 votes
15y
This came from one of my best sources and I am confident he has it right in reference to owning notes.
In my opinion- If your Roth/Pension Plan buys notes as investments (held to produce income/yield) they are OK.
If your Roth/Pension Plan buys notes as inventory (held for sale) they are doing business (hence UBIT).
So buy notes as a passive investment and forget about flipping in your IRA or make sure you are making enough money that the tax doesn't bother you. Buy for yield or yield spread, sit back and enjoy the mailbox money.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
Originally posted by Bryan Hancock:
I guess the question is what the taxing authority considers "held for sale" for UBIT. Any words of wisdom?
For my understanding, I think they consider if you flip more than 1 or 2 in a calendar year, you would be considered holding to sale/flip and thus, be taxed for competing business.
Investor · Kalamazoo, MI · Member since 2009 · 1k+ posts · 495 votes
15y
I believe it is your intent going into the deal. If you are looking to buy and hold then you are not subject to UBIT. If you are looking to buy and flip then just make sure you are making enough money to pay the UBIT and to justify doing the transaction. Just figure it into your equation to begin with. I have not done any flipping in my IRA but, flipping options seems like a way you could make some big hits without much investment.
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
15y
Clearly you can "flip" securities in an IRA without being subject to UBIT. I.e trading stocks, funds, and bonds. In fact day traders flip the same stock many times tax free in IRAs. So the question is, are promissory notes and private mortgages treated the same way by the IRS?
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
I can’t see why they wouldn’t be. I think the intent of UBIT is to keep BUSINESSES on the same level playing field with respect to taxation. I guess one could claim that brokering notes and private mortgages is a business that is separate and distinct from trading securities on an exchange. That would seem to be a stretch to me though.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15y
Clearly the intent behind UBIT is to level the playing field between taxed businesses and tax-exempt businesses when they're doing the same business. And there is clearly an "intent" factor w.r.t. how your investments are treated, as our CPA pointed out when we were dealing with our repo house last year.
Nevertheless, there seems to be a good argument that "flipping notes" isn't much different than day trading stocks and should get the same treatment.
Rents from rental properties are specifically excluded from UBIT by the IRS. So, there is no need for a discussion about "intent" or inventory or anything like that. OTOH, any sort of "active" business gets hit with UBIT.
I wonder if a distinction is that buying stocks, bonds or commodities is a transaction on a public exchange. You don't set the price as either the buyer or the seller, and don't have to take any actions to buy or sell, beyond dealing with the exchange. With a mortgage or note, you have to actively search for both buyers and sellers, and you have some control over the price in both transactions.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Yeah…on an exchange you are basically a “price taker†instead of a “price maker.†I could see that angle being taken by the IRS. I am not sure how impressive it would be to a judge.
A lot would likely depend on whether or not you are in the business of buying/selling notes too. If this is your business and it is how you earn a living I would suspect that the IRS would have a more compelling UBIT argument.
Investor · Kalamazoo, MI · Member since 2009 · 1k+ posts · 495 votes
15y
I'm sorry, what makes you think you can flip securities in an IRA w/out the UBIT? Where is that clear? Just asking as I may have missed something here.....
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
I know of many people that trade securities actively in their SDIRA and it has never even occurred to them to check out UBIT. I am not sure if this is because they are misinformed….that could be the case.
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
15y
Originally posted by Marc Faulkner:
I'm sorry, what makes you think you can flip securities in an IRA w/out the UBIT? Where is that clear? Just asking as I may have missed something here.....
Marc, I don't have the IRC chapter and verse, but it is generally accepted and practiced that you can trade stocks, bonds, and funds in IRA's. In fact my CPA even does so with options and futures in his IRA. You can do this without short or long term capital gains taxes.
Investor · Kalamazoo, MI · Member since 2009 · 1k+ posts · 495 votes
15y
I'm wrong! Here is an explaination:
"Public markets and private sales are very different. Where stocks are traded in a public market it is investments. Where houses, notes & mortgages, etc. are bought and sold in a private market, it is a business with inventory."
Investor · Kalamazoo, MI · Member since 2009 · 1k+ posts · 495 votes
15y
From two people that I would consider experts on the subject. I went on to ask why these would be treated differently just for clarification.
I asked "wouldn't these two: stock flipping and note flipping be treated the same since, the intention is not to buy and hold?
"Nope. It is only a “agency†representing you. With stock, you have market makers who buy and sell, you never meet or even know the buyer or seller. Quite a bit of difference."