Analyze a real- estate opportunity.

The following are the facts for your consideation, but I am sure there are other concerns that  may need to be evaluated and this is the reason I am posting. Tax consequences are of particular concern, ie UBIT or unrelated business income tax in the IRA. 

I have Made an offer which should be accepted on a bank owned property in Manderville, a suberb of New Orleans. The cost will be $170,000 with no significant repairs needed. If accepted I will order a home inspection to verify condition. I have financing lined up for 50% at 6.5% for 20 years. The closing cost will be about $5000 and the owner of the property will be my self directed IRA. Comps on this 3 bedroom 2 bath Single family home are in the area of $240,000. I have a tenant who wants to buy the house but only has $10,000 in cash. He is willing to Rent with the option to purchase in 5 years if the deal is right for him. I calculate the expenses to be as follows:

634 per month 85K @6.5% 20 yrs.

366 per month Taxes

125 per month Ins.

$1,125 per month total for PITI.

The fair market rent for this area would be 1500 to 1700 per month . this would provide a positive cash flow of from $375 -$ 575 a month. This does not account for additonal cost to  maintain the property.

I am considering offering a rental at $1650 per month with a $10,000 Up front deposit to be used towards future purchase and forfieted if the option expires at the end of 5 years.

I would also require an additional 350 a month to be credited toward the purchase in 5 years or sooner. This payment would also be forfieted if the option to buy was not excercised. This brings the total cash flow from the propery to $2000 per month and PITI of $1,125 per month for a net operating income of $10,500 per year. The net outlay is $80,000. ($85,000 down payment + $5,000 closing cost - $10,000 non refundable deposit= $80,000) This equates to a 13.1% Cash on cash Return on investment. If the option is not excercised  I retain the deposit and payments toward the purchase. The deposit money is $31,000 which will be used as a down payment on the purchase price of 205,000.  Upon sale I pay off the remaining balance of the mortgage aprrox. $81,000 , credit the buyer with 31, 000 and retain $93,000 on my original $80,000 cash investment. Total income over 5 years is $65,500   

The option price would be set at $205,000 which provides instant equity to the purchaser and a good return for me as an investor.

The tax conerns within my IRA would be that Unrelated Busness Income Tax (UBIT) would be due calculated on 50% of my net profit on rental income and 15% capital gain on sale of the Propery. This occurs because of the use of leverage in this transaction. I believe that the IRA would benefit from the excellerated depreciation under the GO Zone regulations and would be able to write off 50% of the depretiation expenses atributed to the propery. GO Zone depreciation could offset much of the 36% tax under UBIT. 

The primary risk involved here is that if the tenant decides to leave early, I have an $80,000 investment in a rental property that only nets $6300 per year which would most likely be reduced by maintaining the property and potential vacancy under a traditional rental.

By using Rent with option to buy we can transfer maintenance to the tenant but may we may still require a management company to administer the lease collect the rent etc. I did not include this cost. Is this a deal you would move forward on? Is there a better alternative and have I missed considering some risk such as the oil currently coming ashore In Venice Louisiana and the onto the shores of New Orleans and its impact on the economy of the area.