Tag Archives: traditional ira

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?

The Balancing Act

I traveled to Pompano Beach, FL last week to record a financial segment for “The Balancing Act”, a Lifetime Television show.  A lot of hard work went into this and it went off without a hitch! It was such an honor for me to be on their show, the topic was my personal favorite (and area of expertise), Self-Directed IRAs. I finally got to wear my awesome suit that I have been tweeting about but I wasn’t ready for my lesson on wearing make up and eating spicy food- ha ha!!

See below for the pics And click HERE for the Press Release!

The recording will air on February 19th- Make sure you record your DVRs to watch me appear on National Television!!

How Can My Minor Child Have a Roth IRA?

Article Written by H. Quincy Long in 2012

“How can my minor child have a Roth IRA?” If I only had a million dollars for every time I have been asked this question, I would be a very rich person!  When entrepreneurial people learn of the myriad of possibilities for non-traditional investments within a self-directed IRA, they usually immediately see the benefit of starting on their child’s retirement now in addition to utilizing their own IRAs.  In this article I will discuss the benefits of starting an IRA early, how a minor can qualify for a Roth IRA, the tax filing requirements for a minor with earned income, and what can be done with the IRA once the money is deposited in the account.

First, let me briefly discuss the benefits of starting early on retirement savings.  Assume your 15 year old daughter starts off her Roth IRA with $1,000 from her earnings and adds $1,000 per year until she retires at age 67.  If she can earn an average return of just 10% per year, her tax free Roth IRA will be worth $1,552,472 at retirement – not bad for only investing a total of $52,000 over 52 years.  Contrast this with an individual who starts saving at age 35 and puts $5,000 in for 32 years with the same annual return of 10%.  His Roth IRA will be worth approximately $1,111,253 when he retires at age 67, and  is contributions will total $160,000.  No matter what your age and annual return assumptions are, one thing is very clear – the earlier you start saving the better!

Before you get too excited and start writing your IRA custodian or administrator checks to open Roth IRAs for your minor children, you must make sure that they qualify to make a contribution.  In order to contribute to a Roth IRA, a single individual must have earned income (compensation) at least in the amount of the contribution and Adjusted Gross Income of no more than $122,000 (for 2011).  For example, if your daughter earns $1,000 babysitting in 2011, she can contribute a maximum of only $1,000 to her Roth IRA, even though the contribution limit for individuals under age 50 is $5,000.

How can a minor earn money so they qualify to contribute to a Roth IRA?  The younger your child is, the more difficult it will be to justify compensation if the IRS questions the contribution.  I have heard of parents hiring their minor children as a model for advertising purposes in the parents’ trade or business, but if you intend to do this make sure that you actually use of the photos in your advertising.  Keep track of how and when you used the photos, and have adequate documentation in your file as to what reasonable compensation would be for a model doing an advertising shoot with unlimited use of the photos.  By the age of 8 or 9 children can be of some use to their parents’ businesses by doing things like cleaning up trash in the yard of rent houses, collating materials if the parent teaches classes, stuffing and stamping envelopes, or other menial tasks.  At age 7 my daughter helped me with artwork to put on t-shirts by carefully writing in crayon “Do you have a self-directed IRA?  I do!”  I then had her wonderful artwork turned into a silk screen for the back of t-shirts with my company logo on the front.  I gave away hundreds of the shirts to my clients.  With the unusual writing on the back of the shirts, people asked a lot of questions and it turned out to be one of my most effective advertising campaigns!  Other ways for minors to earn money include cutting grass, babysitting, or working at restaurants and offices when they are a little older.  If you are hiring them in your own business, be sure that you always document the time spent working and pay them a reasonable wage.

The next questions I get asked when discussing Roth IRAs for minors are “What is the tax effect of my child earning compensation?” and “Does my child have to file a tax return?”  I will briefly summarize the rules here, but always check with your CPA or tax professional.  More information may also be found in IRS Publication 929, Tax Rules for Children and Dependents.  A minor child who is a dependent on someone else’s tax return cannot claim a dependency exemption, but can still claim the standard deduction on their tax return if they are required to file.  The standard deduction for a single dependent minor varies between $950 and $5,700 for 2010, depending on the type and amount of income.  In general, for 2010 a dependent minor must file a tax return if 1) unearned income, such as interest and dividends, was over $950, 2) earned income was over $5,700, or 3) if the minor has both earned income and unearned income, the adjusted gross income was more than the larger of $950 or the earned income (up to $5,400) plus $300.  If the dependent minor worked at an employer who withheld income taxes from their paycheck, in most cases they will want to file a return to collect a refund of this amount, even if there was no filing requirement.

There are situations where a dependent minor has to file a tax return regardless of the above filing requirements.  One of the more common circumstances is when the dependent minor has self-employment income (such as from babysitting or cutting grass) of more than $400.  In this case they will owe Social Security and Medicare tax on that income and will have to file a tax return to pay the tax.  For example, a recent tax client of mine who was 18 years old and still a dependent on her mother’s tax return earned $3,183 doing clerical work, for which she received a 1099-MISC.  She was not treated as an employee by the person who hired her, so she was required to file a dependent tax return to report this income.  Because her Adjusted Gross Income was below $5,700 she owed no federal income tax.  Unfortunately, she still owed $487 in Social Security and Medicare taxes.  If she had been treated as an employee, the employer would have paid its portion and withheld her portion of the Social Security and Medicare tax from her paycheck.  In that case she would not have had to file a federal tax return, unless she wanted to claim a refund for any federal income taxes withheld.

There is an interesting exception to the requirement that a dependent minor pay Social Security and Medicare tax on their earned income.  If a child under age 18 works in their parents’ trade or business and their parents’ business is either a sole proprietorship or a partnership in which the parents are the only partners, the income is exempt from Social Security and Medicare taxes.  This exception does not apply if the business is incorporated or if the partnership includes persons other than parents.  The exemption is extended to those under age 21 for work other than in a trade or business, such as domestic work in the parent’s private home.  So if a minor earns compensation of less than $5,700 working in their parents’ trade or business or for domestic work in their private home and they have no other income, no federal income tax or Social Security and Medicare taxes would be due.  This means that no tax return would have to be filed, but they would still qualify to contribute to a Roth IRA up to the amount of their earned income, subject to the $5,000 maximum contribution!  However, just to be safe it may be advisable to go ahead and file a zero tax due return for documentation purposes.  Always check with your CPA or tax advisor to find out if your child will owe state or local income taxes on this income.  More information on the family employee exception to Social Security and Medicare taxes may be found in IRS Publication 15, Circular E, Employer’s Tax Guide, Chapter 3.

What you can do with the money once in a Roth IRA?  The beauty of a self-directed IRA is that even small amounts can be invested in non-traditional investments.  There are at least four ways a small Roth IRA can be invested.  The Roth IRA may be combined with IRAs of other people to make a single investment.  The most IRAs I have seen participate in a single note investment was 10 different accounts, with the smallest IRA investor being only $2,000.  That note had a yield of 12% per year!  Another investment which is common in small IRA accounts is an option to buy real estate.  Once you have an option, you may let it lapse, exercise the option and close on the property, sell the option to a third party for a fee if the option agreement allows this, or even release the option for a cancellation fee from the property owner.  Another variation on this idea is for the Roth IRA to enter into a sales contract, then assign that contract to a third party for a fee.  Finally, the IRA could buy a property with a loan, either from taking over the property subject to the seller’s existing financing, negotiating non-recourse seller financing, or obtaining a non-recourse loan from a private party or another non-disqualified IRA.  However, if the IRA either owns debt-financed property or operates a business of any type (including a real estate dealer business), it may be required to file IRS Form 990T and pay Unrelated Business Income Tax (UBIT).

If your child qualifies, there is no doubt that one of the best things you can do for them is to open a Roth IRA.  Perhaps the best part of this strategy is the time you will spend with your child teaching them the benefits of saving early and the methods of investing their money wisely. This is truly a win-win situation for both you and your child.  Happy investing!