UBTI - Do these provisions apply?

Question

After repairs, we plan to cash-out refi, repay the 401(K) and rent also.  If UBTI on Debt-financed property applies, does it stop when we repay the loan?  Or does it start when we've afterwards collected 1,000 in rent or profits?

This may be a net loss but still worthwhile by providing lower cost student housing for my sons.

My future property will be improved by volunteer laborers (my sons), for the benefit of themselves and with the intent of providing college housing for themselves.  It is bought cash by withdrawing from a general loan from a 401(K) plan.  Pulling out money from tax-sheltered funds for documented college expenses is exempt, I think.

The question is not would an investor do this deal, but can I, the mom of a large family with older teenage children?

Jon Holdman · Answer

Unless you elect special tax treatment for an LLC, its a pass through entity for taxes.  So, it would have no effect.

UBIT applies ONLY to tax-exempt "trusts".  The example used in the IRS docs is a university (a tax exempt entity) having a bookstore.  Income from the bookstore is subject to UBIT.  Its intended to level the playing field so the university bookstore doesn't have a advantage over an regular book store.

If you aren't using an IRA to buy stuff, forget about UBIT.

However, if you are buying rentals, especially in a complex situation like this, you need a CPA.  Not H&R block or TurboTax.  A real, knowledgeable CPA.

Kerry M. · Answer

You said, "You are borrowing the money from your 401k, and then using it to buy a property. Your sons fix it up and then live in it. As long as you personally own the property, UBIT does not apply."

Can I own it in an LLC?

Kerry M. · Answer

Oh, thank you.  I am relieved.  We have a Roth IRA, but no, we are not touching this at all.  Our money source is a loan from a 401k to be repaid monthly, not withdrawn.

Boy, thank you.

Jon Holdman · Answer

If you are doing this with an IRA, you are about to engage in a prohibited transaction.  Don't do this.  The penalties are severe.  Thats the only situation where UBIT would even come into the picture.  But I think you are simply borrowing money from your 401k and using it to buy a house.  In that case UBIT does not come into play at all.  You are borrowing the money from your 401k, and then using it to buy a property.  Your sons fix it up and then live in it.  As long as you personally own the property, UBIT does not apply.

Now, the tax situation is somewhat complicated, but its because you have an "investment property" that is being used by your family.

If you mean you're actually withdrawing the money from your 401k, you will owe taxes.  The only question is whether or not penalties are involved.  Not sure if you can do this to buy a house, even if that's used for college housing.  But if its a loan, there are no taxes or penalties.

UBIT only comes into play when an IRA owns a property.  The IRA is considered a tax exempt trust, and is subject to UBIT in some circumstances.  With respect to your IRA, you, you spouse, your descendants (your sons) and ancestors are all "disqualified persons".  If your IRA buys a property, a disqualifies person cannot work on the property.  They cannot live in the property, either.  Nor can your IRA rent or sell to them.  So, your IRA can certainly buy a property, fix it up, and rent it out.  But you and your sons cannot do the fixing up nor can your sons live in or rent the property.

If you engage in a prohibited transaction - i.e., any transaction with a disqualified person - your entire IRA account is considered immediately and fully distributed.  You will immediately owe taxes and penalties on the account.  If you have more than one account, only the one that engages in the prohibited transaction