by Mat Sorensen | Nov 12, 2013 | Uncategorized
An IRA may invest into a real estate investment trust. Real estate investment trusts (“REIT”) are trusts whereby the company undertakes certain real estate activities (e.g. own or lend on real estate) and returns profits to its owners. An IRA may invest and be an owner in a REIT. As many self directed IRA investors know, a form of unrelated business income tax (“UBIT” tax) known as unrelated debt financed income tax (“UDFI” tax) can arise from real estate leveraged by debt.
Many REITs engage in real estate development activities and/or use debt to leverage their cash purchasing power and as a result may cause a form of UBIT tax known as UDFI tax to IRA owners. Most REITS will not pay corporate taxes and as a result will not be considered exempt from UBIT tax as a result of having paid corporate tax. However, income from REITs is still typically exempt from UBIT and UDFI tax because the definition of a “qualified dividend” in a REIT has been defined to include dividends paid by a REIT to its owners. IRS Revenue Ruling 66-106. Qualified dividends from a REIT are exempt from UBIT and UDFI tax. REITs can be publically traded or private trusts but are not easy to establish. They require at least 100 owners and must distribute at least 90% of their taxable earnings to their owners each year. Despite the general application of exception to UBIT/UDFI tax for REITs, a REIT may be operated in a manner that will not allow for qualified dividends to be paid and therefore income from the REIT would not be exempt from UBIT/UDFI tax. If you’re investing into a REIT with an IRA, make sure you know whether the REIT intends to be exempt from UBIT/UDFI tax or not. As discussed, most will be exempt from UBIT/UDFI tax but some REITs may choose to operate in ways that will not qualify for the exception. Because UBIT/UDFI tax is about 39% at $10,000 of annual income this is something every IRA should understand before investing into a REIT.
by Mat Sorensen | Apr 1, 2013 | Uncategorized
A self-directed retirement account, in short, is a retirement account administered by a custodian who allows your retirement account to invest into any investment allowed by law. The law applicable to retirement accounts allows retirement accounts (such as IRAs or 401(k)s) to invest into any investment so long as the investment is not one of the few that are restricted. This means a retirement account can invest into many “alternative” investments such as real estate, precious metals, or small business stock/membership. Under current law, a retirement account is only restricted from investing in the following:
– Collectibles such as art, stamps, coins, alcoholic beverages, or antiques IRC 408(m);
– Life insurance IRC 408(a)(3);
– S-corporation stock, IRS Letter Ruling 199929029, April 27, 1999;
– And, any investment that constitutes a prohibited transaction pursuant to ERISA and/or IRC 4975 (e.g. purchase of any investment from a disqualified person such as a close family member to the retirement account owner).
Here is an example of some of the most popular self directed retirement account investments; rental real estate, secured loans to others for real estate, small business stock or LLC interest, precious metals such as gold, and foreign currency. These investments are all allowed by law and can be great assets for investors with experience in these areas.
When self directing your retirement account you must be aware of the prohibited transaction rules found in IRC 4975, which prevent your retirement account from engaging in a transaction with someone who is a disqualified person to your account. In short, a disqualified person to a retirement account includes the account owner, their spouse, children, parents, and 10% or more partners. So, for example, your retirement account could not buy a rental property that is owned by your father since a purchase of the property would be a transaction with someone who is disqualified to the retirement account (e.g. father). On the other hand, your retirement account could buy a rental property from your cousin, friend, sister, or a random third-party, as these parties are not disqualified under the rules. The rationale behind the prohibited transaction rule is that the federal government doesn’t want you conducting transactions between parties who are so close to the account owner that there could be a transaction designed to avoid or un-fairly minimize tax by altering the true fair market value/price of the investment. The consequence of a prohibited transaction is disqualification of the retirement account and potential excise taxes and penalties.
In a typical self directed IRA investment your IRA administrator holds your investment in their company name for your IRAs benefit (e.g. property is owned as Retirement Account Company FBO John Smith IRA) and receives the income and pays the expenses for the investment at the account owner’s direction and instruction. Many self-directed retirement account owners, particularly those buying real estate, use an IRA/LLC as the vehicle to hold their retirement account assets. An IRA/LLC is a special kind of LLC which consists of an IRA (or other retirement account) investing its cash into a newly created LLC. The IRA/LLC in turn is managed by the IRA owner and the IRA owner then directs the LLC investments and the LLC takes title to the assets, pays the expenses to the investment, and receives the income from the investment. So, for example, a self directed IRA would invest its cash into an IRA/LLC. The IRA/LLC will then have a LLC bank account and that bank account will receive the IRA investment. The IRA/LLC in turn enters into a contract to buy real estate and then closes on the property with the IRA owner signing as manager of the LLC on the documents. There are many restrictions to the IRA owner being manager (such as not receiving compensation or personal benefit) and many laws to consider so please ensure you consult an attorney before establishing an IRA/LLC. Also, please note that I have two other blog articles on the IRA/LLC structure, which go into more detail on how the IRA/LLC structure may be used. Please contact us at the law firm at 435-586-9366 for a consult on using a self directed IRA or in setting up an IRA/LLC.
