My Experience with UBIT in my SDIRA

11 Replies

People talk about UBIT like a kid talks about a big scary monster under the bed.  Here is my experience as something to reference.  Ready..., Fire..., Aim...

I keept hearing about UBIT at seminars "Be careful, you could get hit with UBIT".  My frustration was there was never any detail behind it so, like any good entrepreneur who is told the can't do something, I started asking why not? and how CAN I?  Here is what I learned.  *** note I am not a lawyer or an accountant so check with your own professionals before jumping in.

I am a midwestern cashflow investor with a self directed IRA. I had 50k in my IRA that I wanted to invest but it was not quite enough to buy a property. With a few more dollars I would have enough but that would leave me with no reserve, a situation I was not comfortable with. To bridge the gap so I could by something NOW I decided to look into a loan to my SDIRA.

I called my IRA company and was told the following, I would have to file a form 990T, and it would have to be drawn up by an accountant. MY SDIRA servicer is owned by a CPA so I asked to talk to on of the accountants. The accountant told me that yes they could do this. My next question was "How does UBIT work". If I borrow 30k and use another 30k of equity to buy a property then the loan represents 50% of the property value and 50% of the profits are taxable. That seems reasonable to me but my next question was, "What happens as I pay down the loan"? the accountant I talked to told me that as I pay down the loan the amount of the profit that is taxable decreases as well. So if I pay off half the 30K loan and now have a 15k loan against a 60k house now only 25% of my profit is taxable. The loan has to be non-recourse, meaning that the only security for the loan is the property that is collateral, they cannot come after me personally if things go south.

Ready...,  Fire...,  Aim

The result was that I borrowed 30k from a private investor that I have worked with in the past in July and bought a 65k house.  My investor gets 10% for 7 years and a payment of $498.04.  I get a property That would take another year or two to save up for and rent it of $925 a month.  the cost to prepare the IRS paperwork $150, the tax owed $141.

Since I only owned the property for half a year I expect I will owe closer to $300 in taxes next year along with the $150 doc prep fee.  Overall I am happy with this deal.  My mom always told me that you only paid taxes when you make money, you can cut your taxes by simply cutting your profits or, in this case pay a small tax that declines over time.

Thank you for sharing! I agree that UBIT is oftentimes presented as a big scary monster, but it's just another part of investing for me now. Initially I had a hard time finding a CPA that would file for a reasonable price, but ultimately got that worked out. 

That is awesome.  Thanks for sharing. I'm sure my normal CPA wouldn't know how to do this and I would have to find a CPA that did.

I have also heard the IRS can look back for problems since your last return. So it can be a good idea to file a 0$ UBIT return to reset the clock even if your aren't borrowing money in your SDIRA. 

@Bob E.

Thank you for your post. You are right that so many investors get intimidated once they hear there is a tax inside their IRA. It is worth taking a deeper look as you did and learning how the math actually works.

For most investors using debt-financing to acquire real estate - either with a direct purchase as you show or as a limited partner in a syndication - the tax impact is trivial.  The net result of the transaction is a higher, leveraged rate of return that would outperform the return of placing the same amount of capital in an all-cash transaction.

@John Underwood   You would never file a return if you are not engaging in a taxable activity.  That would be like a 12 year old with no earned income saying "I'm going to get a job in 4 years, so I better start filing taxes now".  

Originally posted by @Brian Eastman :

@Bob E.

Thank you for your post. You are right that so many investors get intimidated once they hear there is a tax inside their IRA. It is worth taking a deeper look as you did and learning how the math actually works.

For most investors using debt-financing to acquire real estate - either with a direct purchase as you show or as a limited partner in a syndication - the tax impact is trivial.  The net result of the transaction is a higher, leveraged rate of return that would outperform the return of placing the same amount of capital in an all-cash transaction.

@John Underwood  You would never file a return if you are not engaging in a taxable activity.  That would be like a 12 year old with no earned income saying "I'm going to get a job in 4 years, so I better start filing taxes now".  

Sorry but an experienced attorney that goes to tax court against the IRS is the one one recommended that this is a way to keep the IRS from looking back further than a zero dollar UBIT return. 

So yes there are reasons to file a return unrelated to a taxable event. This has nothing to do with taxes and everything to do with asset protection. 

@John Underwood  I am fortunate that my SDIRA custodian is owned by a CPA firm so that made things very easy.  I would suggest that, for custodial accounts, people check with their administrator and see if they have in-house capacity or a firm they recommend.  Most of them probably do this on a regular basis and have it worked out.

For a Checkbook IRA ask your accountant about them doing a form 990T. I read through it when I got it back and it does not look all that difficult. The fact that I was only charged $150 would seem to support that.

@Bob E.

$150 is an insanely low fee to prepare Form 990-T. IRA administrators usually refuse to file any tax forms, for fear of legal liability. CPAs who are familiar with SDIRAs will charge a lot more, often with an extra zero to your number. I guess, you got lucky that your administrator happen to have CPAs on staff and is not afraid to offer tax service.

As far as the difficulty of finding good information on UBIT - correct. Google a book by John Hyre and Dyches Boddiford.

Originally posted by @John Wiedman :

@Taylor L.  I would appreciate if you would share the name of a CPA for UBIT

IRA Tax Services out of Colorado. I have no relationship with them other than that they do the taxes for my SDIRA.