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Unrelated Business Income Tax – UBIT for Solo 401(k) & IRA accounts June 26, 2008

Posted by Jeff Nabers in : real estate, Self Directed IRA Solo 401k , 54comments

If you talk to the average CPA, he’ll tell you that UBIT is the boogeyman and is to be avoided… always. Discussing this topic with an above average CPA (such as Eric Wikstrom of Integrated Wealth Strategies) yields different advice.

The Two Types of UBIT

  1. Triggered from a trade or business – if a tax exempt entity (such as an IRA or 401k) owns a trade or business, the income of that business is taxed at trust rates (i.e. very high tax rates). Both IRA & Solo 401k accounts are subject to this type of UBIT.
  2. Triggered from ownership of leveraged real estate – if a tax exempt entity (including IRA) owns real estate leveraged with a mortgage loan, the portion of that income attributable to the mortgage loan is taxed at trust rates. This type of UBIT is specifically referred to as UDFI – Unrelated Debt Financed Income. Solo 401k accounts & other qualified plans are exempt from UDFI.

Trust tax rates are very high, so it might make sense to avoid Type 1 UBIT at all costs. On the other hand, a close examination of UDFI tends to revoke its “boogeyman” status.

The reason UDFI isn’t a detrimental cost is that non-recourse mortgage loans (the only type an IRA/401k can legally obtain) are typically only offered at a 65% loan-to-value maximum. So this means that the UDFI tax is only payable on up to 65% of the property’s net income. (That’s right – net income. You do get to deduct depreciation and other expenses before paying UDFI tax).

Let’s examine a simple comparison of the taxes payable on net real estate income with 50% leverage: (more…)

Self Directed IRA/401k vs. 1031 and other conventional RE tax strategies June 24, 2008

Posted by Jeff Nabers in : real estate, Self Directed IRA Solo 401k , 8comments

Conventional Tax Strategies for Real Estate

Many real estate investors boast of their tax strategy as involving one or more of the following:

Depreciation – This is a tax concept where the property owner pretends that his property is decreasing in value. For residential real estate, it assumes that the property’s improvements will become worthless over 27.5 years. In commercial real estate, the calculation is for 39 years. During each year of property ownership, the owner can take that year’s pro rata depreciation as if it is a loss against the income of the property… which reduces the taxable income of the property, thus reducing the amount of taxes due. Upon future sale of the property, depreciation normally must be “recaptured” which means that there is no more pretending, and the taxes on the truly realized gains must be paid anyways.

Cash out Refi – This is where the owner of the property will refinance the mortgage. The new loan will have a higher balance than the old one, resulting in “cash out”. Because this is just borrowing, it is not a taxable event. Upon future sale of the property, however, taxes will normally be due on the actual gains anyways.

1031 Exchange – Upon the sale of real property, the gains can be deferred if they are used to purchase property of “like kind” within a certain time period. It goes something like this:

    • Property B must be of equal or greater value to Property A
    • Both properties must be “like kind”. For instance if Property A was U.S. real estate, Property B must also be U.S. real estate.

    So, savvy real estate investors often (more…)

    30 Day Challenge: Can you do without TV? June 22, 2008

    Posted by Jeff Nabers in : Health, Personal Enjoyment, Personal Productivity , add a comment

    I do a lot of things differently in an effort to enjoy my life. Sometimes I forget just how abnormal some of them are. This past week I co-instructed the IRA Association of America professional member enrollment course in Denver, CO. During a lunch conversation, one of our new members asked me what my secret is to accomplishing so much so rapidly. I half jokingly explained that I don’t watch TV. I guess this type of statement is more unbelievable than I had thought because a couple of hours later he still couldn’t believe it: “You really don’t watch any TV at all?”

    “I don’t own a TV,” I explained. “I occasionally watch DVDs on my projector.”

    I don’t watch TV for two reasons:

    Mental & Physical Health – I believe that everything that goes into my body or mind becomes part of me. Turning on the TV means that I can choose to watch what’s available from a menu, but only if I also watch other things which I have no control over – commercials. Our thoughts create our reality. Having others’ thoughts shoved into my brain means letting other people create my reality.

    Time – I want to enjoy my life. Every second is a decision. When I pit TV against snowboarding, snow skiing, wakeboarding, water skiing, bicycling, car racing, motorcycling, playing musical instruments, and traveling to new places… TV always loses. To afford some of these activities (more…)

    Filing Deadlines: 5500-EZ & 990-T June 16, 2008

    Posted by Jeff Nabers in : Self Directed IRA Solo 401k , add a comment

    5500-EZ for Solo 401(k) plans

    If your Solo 401(k) plan assets exceeded $250,000 in value in 2007, a 5500-EZ must be filed by July 30, 2008. This is an informational return used to report plan value to the IRS and does not require any tax payment.

    990-T for IRAs with mortgage financed real estate

    If your IRA owns mortgage leveraged real estate, a form 990-T should have been filed with UBIT payment by April 15, 2008. Unrelated Business Income Tax is one an IRA must pay on the portion of income or gains attributable to the mortgage leverage used. For example, if your IRA owned a property with a 50% debt to basis ratio, then 50% of its income would be taxable at trust rates. While many investors balk at the idea of paying taxes on IRA profits, a tax analysis in most scenarios typically favors paying UBIT over making the same investment with non-retirement funds.