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Self directed Solo 401K


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#1 Dawn_LongIsland_NY

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Posted 10 November 2008 - 11:11 PM

I've been looking at setting up a self-directed IRA and came across another option that may work for me even better - a solo 401K with checkbook control. For the solo 401K, I don't need to set up a separate LLC, and therefore don't need to register in every state I will do business in (because it's set up as a trust), I can contribute higher amounts, you don't file a tax return (except for a 5500 form or something like that if your account goes over $250K), and if I obtain (non-recourse) financing on a property, I have been told that no UBIT tax would be due, which is not the case for a self-directed IRA.

Can any tax experts confirm if UBIT tax would be due if the solo 401k trust obtained a loan on a property? Not a lot of people seem to be familiar with the solo 401K. My CPA didn't even know what it was, and he works with a lot of real estate investors.

Thanks.
Dawn

#2 randian

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Posted 10 November 2008 - 11:55 PM

Can any tax experts confirm if UBIT tax would be due if the solo 401k trust obtained a loan on a property?

No UBIT would be due (IRC Sec 511 (c )(9)(A).

http://frwebgate6.ac...action=retrieve

#3 Dawn_LongIsland_NY

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Posted 11 November 2008 - 11:46 PM

Thanks! I couldn't get the link to work, but I'll give my CPA the IRS reference and he should be good.

Thanks.
Dawn

#4 Dave T

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Posted 12 November 2008 - 09:56 AM

Randian, IRC Section 511 applies to charitable organizations, so I don't see how that section helps.

#5 randian

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Posted 12 November 2008 - 02:32 PM

Randian, IRC Section 511 applies to charitable organizations, so I don't see how that section helps.

IRC 511(B )(1): "There is hereby imposed for each taxable year on the unrelated business taxable income of every trust described in paragraph (2) a tax computed as provided in section 1(e)"

IRC 511(B )(2): "The tax imposed by paragraph (1) shall apply in the case of any trust which is exempt, except as provided in this part or part II (relating to private foundations), from taxation under this subtitle by reason of section 501(a)".

IRC 501(a): "An organization described in subsection (c ) or (d) or section 401(a) shall be exempt from taxation under this subtitle"

An IRA, 401(k), 403(B ), etc is a 401(a) exempt trust.

#6 Dawn_LongIsland_NY

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Posted 12 November 2008 - 11:03 PM

I asked the company who I may have set this up for me. This is what they said:

"Please see IRC 514©(9)©(ii) for Solo 401(k) UDFI exemption." (The first c should be a small c and the second c should be a big C, but it keeps posting as copywrite symbols even when I try to fix it. :wub: )

Now of course that's Greek to me, but I'm hoping someone can confirm if that says a solo 401k is exempt from UBIT tax. They also said they have a determination letter from the IRS that states it is exempt, which they will give to me with the rest of the paperwork when they set everything up.

Is there a website to go to to see what this citation actually says?

#7 Dave T

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Posted 13 November 2008 - 05:47 PM

Randian,

Work through this with me. I still don't get it.

IRC 511(B )(1): "There is hereby imposed for each taxable year on the unrelated business taxable income of every trust described in paragraph (2) a tax computed as provided in section 1(e)"

This clause says that if there is UBIT, it is taxable.

IRC 511(B )(2): "The tax imposed by paragraph (1) shall apply in the case of any trust which is exempt, except as provided in this part or part II (relating to private foundations), from taxation under this subtitle by reason of section 501(a)".

If there is UBIT earned by a trust it is still taxable even if the trust is otherwise exempt from taxation because it is a charitable organization, religious organization,. education foundation, or public interest trust.

IRC 501(a): "An organization described in subsection (c ) or (d) or section 401(a) shall be exempt from taxation under this subtitle"

OK, even though charitable and non-profit organizations are exempt from corporate taxes, and qualified pension plans treated as trusts are exempt from trust income taxes, 511(B )(2) says that UBIT is still taxable even for these activities.

#8 Dave T

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Posted 13 November 2008 - 05:54 PM

I asked the company who I may have set this up for me. This is what they said:

"Please see IRC 514©(9)©(ii) for Solo 401(k) UDFI exemption." (The first c should be a small c and the second c should be a big C, but it keeps posting as copywrite symbols even when I try to fix it. :wub: )

Is there a website to go to to see what this citation actually says?


http://www4.law.corn...14----000-.html

#9 Dawn_LongIsland_NY

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Posted 13 November 2008 - 06:00 PM

Thank you Dave.

If I am reading this correctly (as if it was in English), I believe it does say that the Solo 401K would be exempt from UBIT tax. (The solo 401K is set up as a trust.)

Please let me know if you don't think I am interpreting it correctly.

Thanks.
Dawn

#10 Dave T

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Posted 14 November 2008 - 12:13 AM

Dawn,

IRC 514( c )(9)( C )(ii) says that a qualified trust under section 401 is a "qualified organization"

IRC 514( c )(9)(B)(ii) says that non-recourse debt incurred by a qualified organization is acquisition indebtedness.

IRC 514(a)(2) says that a percentage of the deductions determined by the ratio of the acquisition indebtedness to the cost basis of the property will be allowed against the income generated by the property used in the unrelated trade or business.

IRC 514(a) says that the unrelated business taxable income under section 512 will include the net of
  • the gross income from a debt financed property used in an unrelated trade or business activity, and,
  • the allowed deductions which are directly connected with the debt-financed property.
My short summary is that the debt used to finance your unrelated business activity creates deductions which reduce the taxable unrelated business income calculated under Section 512.

What you have not determined is whether investment in an income producing property IS an unrelated business activity for your 401k . Can't you write the charter for your 401k to include real estate investments in the normal course of your 401k investment activity? If so, then the whole UBIT question seems moot.

Just how I see it. Confirm everything with a licensed tax professional.

#11 randian

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Posted 14 November 2008 - 01:53 AM

514 (c )(9)(C )(ii): For purposes of this paragraph, the term “qualified organization” means any trust which constitutes a qualified trust under section 401

IRC 514 (c )(9)(A ): Except as provided in subparagraph (:wub:, the term “acquisition indebtedness” does not, for purposes of this section, include indebtedness incurred by a qualified organization in acquiring or improving any real property.

A 401(k) is a qualified trust under section 401, hence indebtedness it incurs in acquiring real property is not "acquisition indebtedness", hence there is no UDFI because rents and capital gain from real property are UDFI only when there is acquisition indebtedness.

#12 Dawn_LongIsland_NY

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Posted 14 November 2008 - 04:33 PM

Thanks so much to both of you for going through and clarifying things!

I am moving forward with this (not just because of the UBIT exemption). I'll let everyone know if I run into any challenges!
Dawn

#13 Dave T

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Posted 16 November 2008 - 04:16 PM

IRC 514 (c )(9)(A ): Except as provided in subparagraph ( B ), the term “acquisition indebtedness” does not, for purposes of this section, include indebtedness incurred by a qualified organization in acquiring or improving any real property.


I guess you overlooked the part in the original post where Dawn said she will use NON-RECOURSE debt. Non-recourse debt is debt where the amount of the indebtedness is dependent upon the income generated by the property. Under the exceptions listed in subparagraph ( B )(ii), the non-recourse debt will still be acquisition indebtedness.

#14 Dave T

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Posted 16 November 2008 - 04:25 PM

I am moving forward with this (not just because of the UBIT exemption). I'll let everyone know if I run into any challenges!


Dawn,

Nothing is clarified. I am not convinced that UBIT is exempt. Nothing in the tax codes cited by either you or randian leads me to that conclusion.

In my opinion, you avoid Unrelated Business Income, by making sure that your solo 401k charter makes real estate investment a permitted activity. Consequently, any income generated by the activity is "related" and therefore sheltered within your 401k.

Get an opinion from a professional who specializes in this niche.

While you are at it, get an opinion on the same investment strategy within a self-directed IRA. If real estate investment is a permitted activity within the IRA, I don't see a UBIT issue there either. A professional IRA custodian would be the best person to ask this question. I am sure it has come up many times before.

#15 randian

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Posted 16 November 2008 - 05:40 PM

I guess you overlooked the part in the original post where Dawn said she will use NON-RECOURSE debt. Non-recourse debt is debt where the amount of the indebtedness is dependent upon the income generated by the property.

No, non-recourse debt is debt where the lender can only look to the secured property for repayment, rather than you personally.

http://en.wikipedia....onrecourse_debt




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