Category Archives: Self-Directed 401(k)

UBIT on Assignment Fees

Question:

In the attached article you discuss assignment fees within an IRA. Client is a HomeVestors franchisee in the business of real estate. Do you think doing a contract assignment within a Solo 401(k) would be subject to UBIT? I’m worried that his status of being in the business of real estate could subject his other activities to taxation.

Answer:

You didn’t attach the article, but you’re right the whole assignment issue, or even buy, fix and flip, is lot trickier for Homevestor franchisees and other real estate dealers. The easiest way to think about when UBIT attaches is to think of how that income would be taxed if reported outside of the IRA or 401(k) context. For a Homevestor franchisee it’s pretty easy to see where the problem might be, since a house is merely inventory to be sold to its customers in the ordinary course of business- the very definition of Unrelated Business Income in this context. Another potential challenge for a client like that is that there could be an excess contribution or even a prohibited transaction issue (the PT issue because of possibly providing services to their plans) when they are using their company’s resources to find the deals they invest in. Generally you have a better argument that it was purely an investment if a different Homevestor franchisee happens to find the deal if they will invest through their retirement account. Added to this is the fact that a 401(k) plan has a much higher chance of audit and caution is warranted in the investment selection within a Homevestor franchisee’s plan. I did have one real estate dealer who got his plan audited a few years ago and although they let him get away with some flipping in his plan they did charge him for some UBIT. In this case and many others the old adage that piglets get fed but hogs get slaughtered applies – you may get away with some such activity, but the more you do, especially if that’s your only type of investment activity, and the more money you have for the auditor to be jealous of, the more chance you have for a negative result of some sort. That’s the best I can do for a Sunday afternoon. I hope it makes some sense. There are times when it’s a lot more fun to only provide education as opposed to scary things like tax, legal or investment advice!

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?