Category Archives: Self-Directed Traditional IRAs

UBIT? You Bet!

Questions:

I think the answer to my question. Does Arkansas charge tax on UBIT and UDFI?

in the book 2009 Multistate Guide to Regulation and Taxation of Nonprofits By Steven D. Simpson. Which is found in full online through google books at:

https://books.google.com/books?id=KE5dVpNcWkwC&pg=SA3-PA9&lpg=SA3-PA9&dq=Section+512+of+the+Internal+Revenue+Code+arkansas&source=bl&ots=YFNc-ZE7U0&sig=PpYxNwFJEhq5fd920ha18OXLFkw&hl=en&sa=X&ei=ItEKVdmUOcSwggSMiIOoBQ&ved=0CC8Q6AEwAw#v=onepage&q=Section%20512%20of%20the%20Internal%20Revenue%20Code%20arkansas&f=false

It says that Arkansas does not have IRS code sections 501-529, but that it does tax unrelated business income on income attributable to Arkansas. Since UDFI is Section 514 I assume that there is no state income tax on UDFI. I also believe that attributable to Arkansas means the source of the income is physically inside the state.

This book seems to be a source of answers on UDFI and UBIT for all 50 states or at least a starting place.

I still have the following 3 questions from yesterday in a more simplified form:

 

1) If you pay UDFI on the sale of a depreciated rental property do you also recapture depreciation at a 25% rate?

 

2) If my IRA purchases a condo for nightly rental using debt will it owe UBIT on the nightly rental and UDFI on the profit percentage of the debt?

 

3) In the following  published article you state that UDFI is on Acquisition debt. Does this infer that if I pay cash for the house and then borrow against it later there is no UDFI? In other words is UDFI on all debt or just aquisition debt.

 

https://www.questira.com/why-your-ira-may-owe-taxes-to-pay-or-not-to-pay-that-is-the-question/

 

Definition of “Debt Financed Property.” In general, the term “debt-financed property” means any property held to produce income (including gain from its

disposition) for which there is an acquisition indebtedness at any time during the taxable year (or during the 12-month period before the date of the property’s disposal if it was disposed of during the tax year). If your retirement plan invests in a non-taxable entity and that entity owns debt financed property, the income from that property is attributed to the retirement plan, whether or not the income is distributed.

 

 

Answer:

 

Thanks for the reference and the questions yesterday. Sorry we couldn’t get to all of them on the call.  As far as your questions:

1) I believe the IRA would owe this tax, but I have heard different arguments on this. If you think about it, it wouldn’t make sense to be able to deduct depreciation from current UDFI and then escape it on the sale of the property. However, one CPA told me that if the property had been paid off for more than 12 months so there was no capital gains tax then there wouldn’t be depreciation recapture either. I think this was based on the theory that ‘depreciation recapture’ is really another form of capital gains, technically called ‘unrecaptured section 1250 gains.’ To be honest, I just don’t know.

2) That’s a good question. Certainly running a hotel is considered to be a business operation as opposed to just rental income, so I see where you could assume that the nightly rentals would be UBI and not UDFI. I think that if it is considered to be a business operation then probably all income from that business would be UBI not UDFI. I don’t think you can split the capital gains in that case away and call them UDFI, but once again I’m really not that confident, especially this early in the morning. On the other hand, if it were me I would probably just report it as UDFI and see if the IRS disagreed. There is a lot of ambiguity in this area, unfortunately.

 

3) Another good question, but this one I can actually help you with. 🙂 Acquisition indebtedness is 1) when acquring or improving the property; 2) before acquring or improving the property if the debt would not have been incurred except for the acquisition or improvement; or 3) after acquiring or improving the property if (a) the debt would not have been incurred except for the acquisition or improvement, and b) incurring the debt was reasonably forseeable when the property was acquired or improved. So most likely in your scenario the debt would still be considered ‘acquisition indebtedness.’

 

Here is an interesting brain twister: what if my IRA owns a piece of land with no debt which produces no income but which is expected to be sold within a year. If my IRA borrows money to purchase bank stock, which will not be sold for several years, which property is considered debt-financed, the land or the bank stock? If the answer is the bank stock, then can my IRA escape taxation entirely on the gains from the bank stock because the debt will have been paid off from the sales proceeds of the land for more than 12 months prior to the sale of the bank stock?

MAJOR CHANGE in interpretation of 60 day rollover rule

UPDATE

 

The Tax Court ruled in the case of Bobrow v. Commissioner, T.C. Memo 2014-21, that the one-time per 12 calendar month 60-day rollover rule applies to ALL of the taxpayer’s IRAs, and not to each IRA separately.  This is in direct conflict with information contained in IRS Publication 590 and in Proposed Regulation 1.408-4(b)(4)(ii).

UPDATE:  In IRS Announcement 2014-15, the IRS has indicated that it will withdraw Proposed Regulation 1.408-4(b)(4)(ii) and will interpret the 60-day rollover rule in accordance with Bobrow.  However, in order to give IRA custodians and trustees time to update their administrative procedures and their IRA disclosure documents, the IRS has announced that it will delay the application of the Bobrow interpretation of the 60-day rollover rule until January 1, 2015.

A summary of the ruling is below:

Bobrow, TC Memo 2014-21

The Tax Court has ruled that Code Sec. 408(d)(3)(B)’s one-rollover-per-year rule applies to all of a taxpayer’s IRAs, not to each of his IRAs separately.

Facts. Alvan and Elisa Bobrow, husband and wife, were a married couple who filed a joint federal income tax return. On Apr. 14, 2008, he requested and received two distributions from his traditional IRA in the combined amount of $65,064. On June 6, 2008, he requested and received a $65,064 distribution from his rollover IRA. On June 10, 2008, Alvan transferred $65,064 from his individual account to his traditional IRA. On July 31, 2008, Elisa requested and received a $65,064 distribution from her traditional IRA. On Aug. 4, 2008, they transferred $65,064 from their joint account to Alvan’s rollover IRA. On Sept. 30, 2008, Elisa transferred $40,000 from Taxpayers’ joint account to her traditional IRA.

The taxpayers did not report any of the distributions as income. They claimed that they implemented tax-free rollovers of all of the distributions. IRS asserted that the June 6 distribution to Alvan and the July 31 distribution to Elisa were taxable.

Background. Generally, Code Sec. 408(d)(1) provides that any amount distributed from an IRA is includible in gross income by the distributee. However, Code Sec. 408(d)(3)(A) allows a payee or distributee of an IRA distribution to exclude from gross income any amount paid or distributed from an IRA if the entire amount is subsequently paid (i.e., rolled over) into a qualifying IRA, individual retirement annuity, or retirement plan not later than the 60th day after the day on which the payee or distributee receives the distribution.

Code Sec. 408(d)(3)(B) limits a taxpayer from performing more than one nontaxable rollover in a one-year period with regard to IRAs and individual retirement annuities. Specifically, Code Sec. 408(d)(3)(B) provides: “This paragraph [regarding tax-free rollovers] does not apply to any amount described in subparagraph (A)(i) received by an individual from an individual retirement account or individual retirement annuity if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in that subparagraph from an individual retirement account or an individual retirement annuity which was not includible in his gross income because of the application of this paragraph.”

The reference to “any amount described in subparagraph (A)(i)” refers to any amount characterized as a nontaxable rollover contribution by virtue of that amount’s being repaid into a qualified plan within 60 days of distribution from an IRA. The one-year limitation period begins on the date on which a taxpayer withdraws funds from an IRA. (Code Sec. 408(d)(3)(B))

June 6 distribution to husband failed the one-rollover-per-year rule. The Tax Court ruled in favor of IRS, that the June 6 distribution was taxable because Alvan failed the one-rollover-per-year rule.

The Bobrows asserted that the Code Sec. 408(d)(3)(B) limitation is specific to each IRA maintained by a taxpayer and does not apply across all of a taxpayer’s IRAs. Therefore, they argued, Code Sec. 408(d)(3)(B) did not bar nontaxable treatment of the distributions made from Alvan’s traditional IRA and his rollover IRA. The taxpayers did not cite any supporting case law or statutes that would support their position.

The Court said that the plain language of Code Sec. 408(d)(3)(B) limits the frequency with which a taxpayer may elect to make a nontaxable rollover contribution. By its terms, the one-year limitation laid out in Code Sec. 408(d)(3)(B) is not specific to any single IRA maintained by an individual but instead applies to all IRAs maintained by a taxpayer. In support of this theory, the Court emphasized the word “an” in each place that it appears in Code Sec. 408(d)(3)(B).

The Court then explained its rationale for concluding that the June 6 distribution, rather than the Apr. 14 distribution, was taxable. When Alvan withdrew funds from his rollover IRA on June 6, the taxable treatment of his April 14 withdrawal from his traditional IRA was still unresolved since he had not yet repaid those funds. However, by recontributing funds on June 10 to his traditional IRA, he satisfied the requirements of Code Sec. 408(d)(3)(A) for a nontaxable rollover contribution, and the April 14 distribution was therefore not includible in the taxpayers’ gross income. Thus, Alvan had already received a nontaxable distribution from his traditional IRA on April 14 when he received a subsequent distribution from his rollover IRA on June 6.

Finally, the Court took note that Alvan received two distributions on April 14. It said that it would be inappropriate to read the Code Sec. 408(d)(3)(B) limitation on multiple distributions so narrowly as to disqualify one of the April 14 distributions as nontaxable under Code Sec. 408(d)(3)(A). So, it treated the amounts distributed on April 14 as one distribution for purposes of Code Sec. 408(d)(3)(A).

The July 31 distribution to wife was repaid too late. IRS put forth two arguments as to why the July 31, 2008, distribution was ineligible for nontaxable rollover treatment: (1) the funds were not returned to a retirement account maintained for Elisa’s benefit, and (2) repayment of funds was not made within 60 days.

As to argument (1), IRS asserted that because she distributed the funds first to the taxpayers’ joint account and the taxpayers thereafter transferred $65,064 from their joint account to husband’s rollover IRA, the July 31 distribution was paid into an IRA set up for Alvan’s benefit and not into an IRA set up for Elisa’s benefit. The Court disagreed with that argument: it said that money is fungible, and the use of funds distributed from an IRA during the 60-day period is irrelevant to the determination of whether the distribution was a nontaxable rollover contribution.

The Court did agree with IRS’s second argument. Partial repayment was not made until Sept. 30. Sixty days after July 31 was Sept. 29

How many Real Estate transactions can I complete in a calendar year?

Question:

Quincy

With my Quest Roth IRA and utilizing the PPT, how many real estate transactions can I complete in a calendar year. Specifically optioning  a property then, assigning the option and pocketing the assignment fee.

 

Answer:

 

 

There is nothing that indicates a specific limit on how many such transactions you can do BUT (and it’s a big BUT) there are some potential areas of concern.  An IRA is meant to be for investments only, and not necessarily for running a business.  So if you are in the business of buying and selling property, or buying and selling options on property, then your IRA may be subject to unrelated business income tax on its profits from that business.  So how many can you do before it’s considered to be a business?  Nobody knows.  It has to do with intent, and volume, and how exactly the business is handled.  The best hint I can give you is that if you would report your activity as business income outside of your IRA, then it is almost certainly business income inside your IRA, and taxes will be owed by your IRA on its business profits. You should consult with your CPA on this issue.

 

Another issue you will want to consult with your CPA on is the tax filing requirements for your personal property trust.  My experience has been that many people using trusts ignore completely the tax filing requirements for trusts.  If your trustee is using Optional Filing Method 1 instead of filing a 1041 for the trust, then you don’t have to report anything to the IRS, but you will want to make sure that option is available for your trust activity reporting and that the conditions for using this option are acceptable to you.  I did write an article on this topic and if you like I can send you a copy of it.  Or you can just look it up on my blog at www.irawebadvisor.com.

 

A bigger issue involves who is doing the activity.  If you are essentially running a business inside of your Roth IRA, then you may be considered to be contributing your services to the Roth IRA.  This has the potential to be considered by the IRS as an excess contribution under IRC Section 4973, or a prohibited transaction under the prohibited transaction rules of IRC Section 4975(c)(1)(C) (the provision of goods, SERVICES, or facilities between a plan and a disqualified person).  It may also be considered an abusive Roth transaction which falls under IRS Notice 2004-8, in which case it is a listed transaction that you must specifically report in order to avoid severe penalties.

 

If it sounds like I’m trying to scare you off of using options, I am not.  I am simply pointing out that you cannot donate your personal services to your Roth IRA where the IRS will never get its share of the money.  You may make as much money as you like on your INVESTMENT activity.  You may even own a business in your Roth IRA, but you personally cannot run that business, and the business must pay taxes on its income, either through the entity that owns the business or directly by the Roth IRA if the entity running the business is non-taxable.  There is often a very fuzzy line between investment selection (which is no problem) and providing services.  Some people are willing to dance closer to the line than others, and there are no definitive answers.  The analysis is very fact specific, so there is no bright line answer to your question.

 

One thing I think is fair to say is that “piglets get fed but hogs get slaughtered.”  By that I mean that too much of a good thing can cause the IRS to take the position that what might otherwise be investment activity changes its character to business activity.  The higher the dollar amount involved the higher the level of interest by the IRS will be if they audit.  Generally it is a good idea to have more than just one type of investment activity to avoid the appearance that you are simply creating options as inventory to be sold off for a profit.

 

As you know I cannot give you tax, legal or investment advice.  Hopefully the information above will give you and your tax or legal advisors some areas to analyze.  Good luck with your investments, and have a great day!

 

Could I just make a personal loan to my partner in the LLC and he could the pay down the hard money loan?

Question:

I currently have a self-directed IRA and have some cash in it from a recent deal. I am a 50% owner of an LLC with a hard money loan on a home we are currently trying to sell. Basically, I need to determine a safe way to invest(not take a distribution) my Ira money so that the money can ultimately pay off part of that hard money loan.

1.  Could I just make a personal loan to my partner in the LLC and he could the pay down the hard money loan?  He is not related to me. Or is this just too direct a transaction?

2.  I know another real estate investor who has nothing to do with the LLC who is willing to help in any reasonably safe way. Do I have my IRA do a promissory note to this investor who then loans the money to the LLC? Do we have the loans for differing amounts of money? Do we do any of this using some instrument other than or in conjunction with a promissory note, i.e. a second mortgage on the investor’s home and a second on the home that the LLC is trying to sell?

Please advise on the safest way to invest the IRA and get the loan paid down.

Answer:

Unfortunately, there is probably no safe way to accomplish what you want to do.  You should understand that your partner in the LLC is, in fact, a disqualified person to your IRA.  The reason for this is that any entity owned 50% or more by an IRA owner is a disqualified person to the IRA, which means that your LLC is a disqualified person to your IRA.  Furthermore, because your partner owns 10% or more of your LLC, he or she is also a disqualified person to your IRA.  So loaning money to your LLC or your partner is out of the question as a direct violation of the prohibited transaction rules.

 

In your second scenario, what you describe is a step transaction.  Unfortunately, you are not permitted to do indirectly what you cannot do directly under the prohibited transaction rules.  Since your IRA money cannot be used to pay down the hard money loan directly, trying to take two steps to accomplish the same goal does not work either.  Even if you make it harder to detect what is going on through the use of different loan amounts or different timing of the loans, unfortunately it will not change the basic fact that as a direct result of your IRA’s investment in a loan to your non-disqualified investor friend you, your partner and your LLC will all benefit from having the hard money loan paid down.  This would also be a prohibited transaction.

 

If you have not taken a distribution from your IRA in at least twelve months, you could take a distribution and as long as you returned the money to your IRA or another IRA within 60 days it would not be taxable.  Of course the danger of this strategy is that if you were unable to return the money to the IRA it would be taxable and you would possibly face penalties if you are under age 59 1/2, assuming the IRA you refer to is a traditional IRA.  If you were able to return part of the money to the IRA, then only the part that you were not able to return would be taxable.  This may not be the best strategy for you to deal with your issues, given the level of risk involved, but at least it would avoid the danger of a prohibited transaction.

 

I’m sorry I was not able to offer you a solution to your problem.  We are not permitted to give tax, legal or investment advice, but I hope I have given you and your legal or tax counsel some things to think about.  If Quest IRA can ever be of service to your or your acquaintances, please do not hesitate to contact us.  Have a great day!