I personally don’t like these QRPs or qualified retirement plans (Roth-IRA, Solo 401ks, etc) if you are an active real estate investor. But if you have money locked up in an old IRA or 401k this is a great way to get that money out to invest in your deals or syndications.
If you are conservatively using prudent leverage and finding decent deals there is no reason you should not be able to retire in 10 years or less and thus negating the very reason for these accounts. I don’t know about you but I want access to this money to play with well before I am sixty-something.
When you have money in these accounts it sounds good that you are not taxed on gains but you are restricted from getting a Fannie Mae loan. Using the QRP loans get you the second tier financing options, for example, a Roth IRA can buy real estate on leverage, however, will need a non-recourse loan which is often a fraction high-interest rate and lower LTV. No Bueno!
Info on using retirement funds for syndication deals:
Question: I am considering investing in a 506c investment on a multifamily property. They are raising a 1 million from investors, then getting a loan and making improvements to the property and repositioning it over 5-7 years. I wanted to use my funds from my SEP IRA which is currently in a qualified intermediary trust. What is the UBIT tax? Will I be subject to that on this deal? Also, should I set up an LLC that then loans the money to their LLC? How can I structure this for tax and liability benefits?
Answer [Note: From CPA and not this is NOT legal or professional advice]: When you invest in a business (syndicate = business) with your IRA, the IRA will be subject to UBIT (unrelated business income tax) and UDFI (unrelated debt financed income).
For our purposes, UDFI is produced when an IRA uses debt to purchase real estate. Essentially, the portion of the property’s income considered UDFI is based on the percentage of rental income derived from debt.
For example, Property A is purchased for $100,000. You put down 25% of the purchase price as a down payment and finance the remaining 75% with a traditional mortgage from the bank. The property produces $10,000 in net income for the year. $7,500 (75%) of the net income is considered UDFI and is subject to UBIT.
There is a deduction for the first $1,000 of income subject to UBIT. Income subject to UBIT over $1,000 is taxed at trust rates. For 2017, trust tax rates start at 15% and max out at 39.6% after just $12,400 of income subject to UBIT.
UBIT is paid by the IRA account. If for whatever reason UBIT is paid directly by the taxpayer, the amount paid is considered a contribution to the IRA.
Follow up question: Is there any difference in how the UDFI will apply for these:
1) SD IRA
3) Solo 401K
4) SD IRA (operated as an LLC) so this one is confusing… My LLC owns an LLC (syndication) which owns a property such as 150-unit on 123 main street
Question: I’m trying to decide if one is better than another for tax purposes?
Answer: The solo 401(k) is not subject to UDFI but it subject to UBIT. The IRAs are all subject to UBIT and UDFI. Note that generally the passive income flowing back to you is very low and the, as a result, we don’t see a huge UBIT tax.
Another idea would be to take a debt position (lending) rather than equity. The interest you would receive is free of UBIT and UDFI tax.
(This suggestion of a “debt” position or note investment with the SEP IRA to avoid UBIT and UDFI tax is a creative one… but it’s a very low chance of happening because it’s just too complicated and honestly not worth the effort from the syndicators’ side. It’s a very similar case of to a Tenant-In-Common (TIC) arrangement where an investor has 1031 exchange funds and wants to parlay that money into a syndication. It’s possible but from the syndicator’s perspective a lot of unneeded work when you can just raise the funds the traditional way. Caveat: if you are bringing in a huge amount of money say 50% of the raise then that might tip the scales in your favor)
Ask you can tell this is a really grey area. One CPA mentioned, the answer depends on how you structured the syndication, UBIT may or may not apply for the real estate holding for solo 401k. I would really try to toss the Operation Agreement to your individual CPAs to examine and determine ahead of time as I am not a CPA 😉
Caveat: If you are late to the game and already have a fat 401k then you should convert it to a solo401k. At that point, you should think about putting it into a syndication since you are restricted on how you can leverage it.
So if you are going to have one of these QRP accounts since you have an old 401K or old retirement accounts want to self-direct it in good investments and don’t want to take a huge tax hit right away set up a Solo401k or Checkbook control.
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