UBIT? does it apply 4 SDIRA lending

6 Replies

Hi all-

I’ve done quite a bit of reading and searching the forum - some posts came close to my scenario but not on the mark. 

For 3 years I have been JVing with a partner to buy Mortgage Notes (6 plus to 1ur holding) - simple process of funding to buy the Note, receive % split on income and same doing a % split for selling - all proceeds went back to SDIRA. Simple model that works well. No issues like having to foreclose and nothing that required additional funds from IRA.

Now I’ve been presented with a different investment - new for me.

The JV partner already owns the property and has been rehabbed and currently has a renter. All the essentials are in place like insurance, home owners warranty (already rehabbed but carrying as a precaution) and taxes paid. I will have to find out if they expect only renewed taxes and insurance to be SDIRA responsibility.

They currently want to refi and pay off original investor that got them through the purchase and rehab.

In walks my money SDIRA (not a ROTH so all tax deferred) to refi and also partner on holding the investment for rental income.

Anything can happen even though it's rehabbed with a home warranty - all expenses are 100% on the investor side (my IRA) which means if additional money is needed that the rent does not cover, my IRA will have to pay the expense. At this point I see why I never ventured down this path.

Will the IRA be subject to this UBIT or other tax?

I found several posts that get into a more strict and complicated investment and that does not apply here.

Any help is appreciated?

@Dmitriy Fomichenko I know you deal in this and I found several of your posts. Is it a simple cut and dry process with no adverse affect of taxing? What else should I be asking or looking to educate myself on with respect to using my SDIRA to finance (lend) and hold a property for rent?

Thank you all...

@Daria B.

I'm not sure I fully understand this proposed investment... Will you be lending your IRA funds to this person? Will there be a promissory note detailing loan amount and interest paid. Or will you become the part owner of the property? Will your IRA go on title?

If you make passive investment such as private loan - there would not be any issues with UBIT, all income will be sheltered from taxes. If you engage in an active business such as flipping - UBIT may apply, be sure to speak with knowledgeable CPA to understand the tax liability. 

Hope this helps!

@Daria B.

As I understand your transaction your IRA is holding a mortgage note. If that is the case, then mortgage interest on a note is passive and not subject to UBIT.

UBIT applies when a tax-exempt entity engages in a trade or business on a regular or repeated basis.

Passive income not subject to UBIT includes royalties, dividends, interest, rent from real property and gains on the sale of an asset that has been held to produce such passive income.

Trade or business subject to UBIT generally consists of services or buy/sell transactions.  Repeated flipping of homes or new home development for immediate sale are the types of things in the real estate space that can trigger UBIT.

Originally posted by @Dmitriy Fomichenko :

@Daria B.

I'm not sure I fully understand this proposed investment... Will you be lending your IRA funds to this person? Will there be a promissory note detailing loan amount and interest paid. Or will you become the part owner of the property? Will your IRA go on title?

If you make passive investment such as private loan - there would not be any issues with UBIT, all income will be sheltered from taxes. If you engage in an active business such as flipping - UBIT may apply, be sure to speak with knowledgeable CPA to understand the tax liability. 

Hope this helps!

 Hi Dmitriy 

I had two options:

1-lend to allow them to pay back original investor, which would be interest only payback including capital at end of term

or

2-equity position whereby I put up $xxx to allow them to payback original investor (no interest paid on lent money) with equity income (rental).

I chose option 2 for the income so it would be part owner.

As with previous deals (Mortgage Notes) my IRA was on the deed and a promissory note was created as a result of the lending with a mortgage.

As I read your questions and write in response I am now wondering if this is typical. Essentially, I’m lending free money (no interest) and only receiving rental income (split 50/50) including split (50/50) on sale of property. The sale would make me whole from the capital and also include profit. So I guess it’s one or the other when option #2 is in play. I don’t know if others pay interest on money lent to them and also rental income and split sale proceeds.

Anyway, I will not have any hands on the property. The JV is assuming all responsibility for upkeep and paying bills (although my IRA has 100% responsibilities for expenses).

I believe my custodian may require a promissory note / Mortgage regardless of terms as protection- am following up with them tomorrow. And as protection I should want it as well.

Does that make better sense?

Originally posted by @Brian Eastman :

@Daria B.

As I understand your transaction your IRA is holding a mortgage note. If that is the case, then mortgage interest on a note is passive and not subject to UBIT.

UBIT applies when a tax-exempt entity engages in a trade or business on a regular or repeated basis.

Passive income not subject to UBIT includes royalties, dividends, interest, rent from real property and gains on the sale of an asset that has been held to produce such passive income.

Trade or business subject to UBIT generally consists of services or buy/sell transactions.  Repeated flipping of homes or new home development for immediate sale are the types of things in the real estate space that can trigger UBIT.

 Thanks Brian-

This is a great statement and what I was looking for:

“Passive income not subject to UBIT includes royalties, dividends, interest, rent from real property and gains on the sale of an asset that has been held to produce such passive income.”

It will help me with further research on this topic. Not always sure where to start looking for answers.

As I mentioned to Dmitriy, I still have finite details to absorb. It's the tax implications or UBIT for the fact that additional monies may be needed from the IRA after the initial purchase.

@Daria B.

I am somewhat confused like @Dmitriy Fomichenko however with your further explanation I see the following:

Option 2 -your Ira purchased 50% of the property and there is no debt. In addition, your IRA agreed to fund any cash shortfalls and the partner does all the management. I assume your Ira is now on the deed as 50% owner. If this is the case no UBIT UDFI applies as this is not a business and there is no loan.