by Jeff Dixon, MBA, CISP, SDIP – Vice-President of Business Development
An IRA can owe taxes?
Here’s a surprise! Your IRA can be taxed! Yes, that seems counter-intuitive. After all, aren’t IRA funds supposed to be taxed later in life when distributed from the retirement account?
IRAs grow taxed-deferred or tax-exempt from personal income taxes when taken as a distribution after age 59 1/2. Because the IRS views certain activities as taxable, there are investment situations that lead to the IRA needing to file its own tax return.
What are these IRA taxes?
Borrowing money in an IRA will lead to a tax called Unrelated Debt Financed Income Tax (UDFI). The Solo 401k is generally exempt to this tax.
The only type of loan the IRS allows to be used by an IRA or Solo 401k is called a non-Recourse loan. It is made to the IRA with no personal guarantees from the account holder or prohibited parties to the account holder. They must be portfolio loans and cannot be sold on the secondary market. Non-Recourse means that if the lender has to foreclose on the property, all they can do is take the property. They cannot go after other assets in the IRA or against the account holder personally. Since these loans are non-Recourse with no personal guarantees, the down payments are usually 40-50%. The interest rates are above market.
Most banks and mortgage companies have no interest in making these loans. We keep a list of lenders that will assist. If you contact us, we will be happy to send our list.
Consider a transaction where you put down 40% and finance 60% of the property. Since there is 60% financing on the property, 60% of the rents are potential taxable. You show 60% of the rents on the 990t tax return. You also write off 60% of the expenses. If there is a net profit, the IRA would pay the tax.
UBIT – Unrelated Business Income Tax
There is another tax called Unrelated Business Income Tax (UBIT). When an IRA or Solo k is running an active business, like a dry-cleaning business, this tax is applicable. Rental property flips, Airbnb, real estate and Bed and Breakfast real estate can also trigger the UBIT tax. Jeffrey S. Tannenbaum states in his article from October 2021 that the UBIT tax rate is 21%.
It is important to note that you can never work for or earn personal income from this business. Neither can a prohibited family member. Here is a link to prohibited parties. Click HERE
The tax form used for reporting these taxes is the 990-T.
You can read more about these taxes at www.IRS.gov Pub 598.
Here is a link to related information on our website. Click HERE
Contact uDirect IRA Services
If you want additional information on this issue or any Self-Directed IRA issue, please contact us at 866-402-2781 or email us at info@uDirectira.com.
For legal or tax questions, please reach out to your own attorney or tax advisor. No information in this article should be considered financial, tax, or legal advice and may not be relied upon as such.
