Self Directed IRAs And Double Taxation!
I've just got off the phone talking to a tax professional who provides guidance for setting up an LLC that is 100% owned by a Self Directed IRA. You may have seen the advertisements elsewhere - "Get checkbook control over your IRA". When I explained to him that my "investing" activity would likely rise to the level of "dealing" he advised me that the LLC would be required to pay UBIT at the corporate tax rate. After I hung up the phone I got to thinking that my gains would ultimately be double taxed. For instance, if I had a gain of $100K in my first year the LLC would have to pay approximately $25K in corporate tax then when I later withdrew the balance of $75K (at retirment after closing the LLC)that amount would in turn be taxed as personal income (this is a traditional IRA). in contrast an LLC funded with non IRA funds would be taxed once only. Has anybody else come accross this or have I missed something somewhere along the way?[ Edited by gprint on Date 05/19/2004 ]
do you have a friend w/ an ira?You might be able to use his money and he use yours, thus eliminating at least one tax. Have you talked w/ "entrust", they are a ira custodian. Good luck
I have my Self Directed IRA with another custodian. While I did not discuss the issue in as much detail with them (since they "do not give specific tax advice"
they did confirm the concept of UBIT and Dealer status.
To your point of cross funding I believe the double taxation still exists. i.e. the funds still get taxed at the corporate and the personal level.
If my understanding of the situation is right I will need to find a way forward as an investor and not a dealer. Maybe this will mean fewer and larger investments. If anybody has thoughts on how I can accomplish this I would appreciate hearing from them.
There are times when I believe that TCI is the greatest source for REI knowlege anywhere. This is one of those times.
Although I do not have an IRA and no plans for one this is a totally different idea that I have never heard of.
I love knowlege and new ideas and its times like this that excite me and keep me modivated!
Thanks for the great idea!
I've reread the forum link "Are Their Any Real Estate Dealers Out There" . I think that pretty much covers the investor vs dealer issue.
"Got to thinking that all the marketing hype from the Self Directed IRA Custodians has "dealer" implications. Aggressive short term multiple "investments", the sort that draw the advertised enormous returns clearly rise to the level of dealing. So it’s down to the UBIT and the double taxation issue. Or am I misunderstanding the situation and really missing something?
‘Would appreciate feedback from anybody who “invests” heavily with IRA money, whether directly or under the cover of an LLC.
As I understand your strategy, you plan to use your IRA funds to flip properties, keeping the profits in your IRA (hopefully tax deferred).
The problem is that property flipping is an active income business and not an "investment" activity or a portfolio income activity. Holding stocks and bonds in your IRA is a portfolio income activity. Holding real property for rental use and/or future appreciation in your IRA is an investment activity.
The UBIT rules come into play because, with property flipping, you are engaged in an active business activity within your IRA even if the deals are fully funded within your IRA.
Cross-funding your friend's IRA and your IRA does not get you past the UBIT issue as long as your IRA is engaged in an active income business. This only compounds the UBIT problem because you are using external financing to conduct your business within your IRA.
To get around the UBIT issue and still participate in property flipping, form a limited partnership outside your IRA. Use the LP to conduct your property flips, then distribute your profits among all the partners. Have your IRA purchase shares in your limited partnership as a limited partner. When the partnership profits are distributed to the partners, your IRA share of the flip profits keeps its tax deferred status with no UBIT issues to contend with.
Run this strategy past your IRA custodian and see what reaction you get. Come back and report.
DISCLAIMER: I have never dealt with UBIT first hand, and my (possibly imperfect) understanding on this topic is only derived from my own readings. I do not have and most likely never will have an IRA, so it is unlikely that I will ever experience the UBIT issue first hand.[ Edited by DaveT on Date 05/20/2004 ]
DaveT
Thanks for your suggestion - just the sort of feedback I was looking for. I will indeed have a chat with my Custodian and let you know what I find out.
gprint
I'm interested in getting to the bottom this, as I have found conflicting info.
If you're IRA owned 100% of the LLC, the LLC would never have a profit, wouldn't all be distributed to the IRA
As for the double taxation, an llc w/ non-irs money would be tax on each property, where as the IRA money if taxed once.
e.g.
in your example, 100K back to you on schedule c, 32% state and fed tax (or your rate) leaving 68K to invest, same thing next, and so on.
IRA, taxed once at distribution.
Apparantly, before the "profits" (gains) from the IRA owned LLC are "distributed" to the IRA the LLC is assessed UBIT at the going corporate rate. This is roughly $25K on $100K profit just for federal taxes, leaving $75K. When the $75K is finally withdrawn from the IRA it will be assessed tax at the going personal rates (for a traditional IRA). UBIT crops up when "dealing" as oppossed to "investing", i.e. when running a business with the IRA funds. I have yet to find a way to avoid the UBIT. "Partnering" with the IRA doesn't appear to help either. From what I have been told so far the IRA share of any partnership is still subject to UBIT.
I am still looking for a "way out" and would love to hear from someone who has discovered a legal method to avoid UBIT.[ Edited by gprint on Date 05/31/2004 ]
You may consider starting up some entity that is solely owned by your IRA and that entity's business plan is to invest in other businesses. It just so happens that these other businesses are also owned by you and that the business invests in real estate.
You should consult a professional here.
If the principal purpose stated in the LLC operating agreement is:
Real estate buying, sell, developing, and all ofther forms of real estate transactions
Why would UBIT be assessed. Most of the reading I did on UBIT had to do w/ income into non-profit from car sales, marathons, etc.
I asked in the (general feedback?) forum about setting up a ira/sep/401k real estate forum that these conversations could be centralized.
cjmazur
From what I have read the IRS rules that relate to applying UBIT to non-profit organizations that make significant profits in a "business" like manner apply also to IRAs that do the same. Every expert I have called has said that I can count on paying UBIT if I use my IRA funds to run a business for profit. Try calling the various self directed IRA custodians and ask them the question. Or try the "IRA Checkbook Control" guys that advertise here on TCI and ask them the same. If you can find a knowledgeable CPA ask him/her the question. None of my contacts have come out and said that I can confidently avoid UBIT. Now the really GRAY area is when IRA investing becomes dealing. Holding properties for rental seems to be clearly an investing approach and is safe from UBIT. However, flipping properties frequently for short term gains is, by all measures, dealing and therefore subject to UBIT. I've read on this site and elsewhere that if you flip six or fewer properties a year then you may be "safe" and can claim investor status. However, I have also read that if your intent is to flip and make a profit then you are dealing even if you do one a year. I tend to think that the IRS will take the latter position because it is all about intent and not about volume.
I continue to research this issue and if I have a breakthrough and can see a legal way to use my IRA funds in a business and avoid UBIT I will post my findings here. Again, if someone here has found the magic formula I would be interested to hear. [ Edited by gprint on Date 06/04/2004 ]
If your goal is minimize the tax paid and avoid the "status" of Dealer shouldn't the corporation structure of a C Corp be used. It is my understanding that forming a C Corp and investing in RE would avoid the IRS's label of "Dealer". Therefore, the C Corp would not be required to pay the Self Employment taxes (15.3%). A C corp can also create a 401K account that can be used to invest in RE that would be tax deferred. From all the research I have seen, this is the answer w.r.t. the dealer problem. Am I seeing this clearly? It is also my understanding that an LLC and S Corp can be used for RE investing, but because these corp structures have their profits flow back to the individuals' income tax (Schedule C), they CAN be labelled as a Dealer by the IRS with the very first deal. What has your research found?
Didn't Date T already solve the problem for you? He said earlier in this thread:
"To get around the UBIT issue and still participate in property flipping, form a limited partnership outside your IRA.
Use the LP to conduct your property flips, then distribute your profits among all the partners. Have your IRA purchase shares in your limited partnership as a limited partner. When the partnership profits are distributed to the partners, your IRA share of the flip profits keeps its tax deferred status with no UBIT issues to contend with.
If the IRA buys shares in a real estate limited partnership -- an independent entity outside the IRA -- wouldn't this be the same as the investing you do when you buy exchange listed stocks in the IRA?
So far you seem to have only concentrated your discussion on entities owned by the IRA. What about having the entity outside the IRA? If the IRA owned 98% of the limited partnership shares, wouldn't nearly all of the LP profits pass through to the IRA tax free?
If the LP won't work, how about a S-Corp instead? S-Corp dividends pass through to the shareholders free of corporate taxes.
gprint:
A question and a comment.
Question: WHERE is the ad on this site for "the checkbook control" guy???? I've contacted a couple of orgaization which market such a program. I didn't know there was a source in my own backyard.
The IRA-LLC concept has merit if handled properly. I think it will be abused not so much by the UBIT question but rather via prohibited transactions. Once a "wingnut" gets control of the checkbook- watch out.
Comment: As you well state, dealer status is based on intent.
The UBIT was put into place to level the playing field between businesses which pay taxes and non-profit/tax exempt/tax deferred entities which dont' pay taxes. That's only fair.
There have been a number of symposiums and conferences at Universities on the UBIT question. I've read a couple of papers on the subject. I doubt that you will get a definitve anwer from "tax experts" on this subject. The jury is out.
It would be prudent to leave flipping out of your Self-directed IRA-LLC. Those types of transactions should be seperated from investment type transactions.
sammyvegas
The ads I refer to cycle through the "Ads by Google" which appear to the right of the forum message threads. TCI makes available (NOT ME) ads from Guidant Financial and The Tax Academy. Possibly these are the two you have contacted.
This puzzles me or as other people of said the jury is out.
How is buying GM stock which has the primary business purpose of building and selling cars, any different from an IRA investing in CJM, LLC whos primary business purpose is flipping houses?
I don't see how the purchase of LP shares changes the story either.
Would funding notes be any different, since it's just making interest.
I agree that abuse of the alternative investment retirement account is going to be huge.
About having the Sub-S be owned by a SD IRA, that's not legal. A S-corp must be owned by individuals and in some cases, a trust. You could try a C-corp, but you have double taxaction there, too.
If the jury is still out, then why is it dealer status if funds from the IRA are "loaned" to the entity of choice and that entity uses those funds to flip properties, returning to the IRA the original loan amount plus fees and interest? What's the difference between that and buying stock, holding it and then getting the money back - why isn't that dealing?
And what if I buy options? Options are almost always short term - wouldn't that also be considered dealing, even though it's a portfolio activity? I would think there are several creative ways around the UBIT, all legal until otherwise stated by the IRS.
Quote:
On 2004-05-20 00:40, DaveT wrote:
To get around the UBIT issue and still participate in property flipping, form a limited partnership outside your IRA. Use the LP to conduct your property flips, then distribute your profits among all the partners. Have your IRA purchase shares in your limited partnership as a limited partner. When the partnership profits are distributed to the partners, your IRA share of the flip profits keeps its tax deferred status with no UBIT issues to contend with
This is incorrect. A tax-exempt entity does not avoid UBIT by being a passive partner in an active business. The only way to avoid UBIT is to have your IRA own shares in a C corporation. While the corporation will pay corporate tax, an IRA doesn't pay tax on C corporation dividends. As to the double-tax issue, clearly a conversion to a Roth IRA would be the way to solve that problem.[ Edited by 4e6zbi102 on Date 06/10/2004 ]
Quote:
On 2004-06-09 01:57, cjmazur wrote:
How is buying GM stock which has the primary business purpose of building and selling cars, any different from an IRA investing in CJM, LLC whos primary business purpose is flipping houses?
GM is a C corporation, which is a separate taxable entity from its owner, while an LLC (usually) has passthrough tax treatment, attributing its income directly to its owner. If you want an active business in your IRA, have it fund a wholly owned C corporation. Then you can be a dealer, borrow money, and do all those nasty things your IRA can't do by itself. You'll pay corporate tax (UBIT is the same rate), but it's a lot cleaner to show dealer activity on an 1120 than on an IRA informational return.
Quote:
Would funding notes be any different, since it's just making interest.
Funding notes would be different, as long as you aren't flippng them. Interest income is acceptable income to a tax-exempt entity.[ Edited by 4e6zbi102 on Date 06/10/2004 ]
I thought the issue w/ UBIT is investing in a business activity that is not the purpose of business itself.
So how does the entitystructure matter? Mutual funds are not c-corps and I can buy the in an IRA
.
Quote:
On 2004-06-09 02:30, heatherham wrote:
You could try a C-corp, but you have double taxaction there, too.
Not if he converted to a Roth. Then the dividends would never be taxed.
Quote:
If the jury is still out, then why is it dealer status if funds from the IRA are "loaned" to the entity of choice and that entity uses those funds to flip properties, returning to the IRA the original loan amount plus fees and interest?
It's not dealer activity, it's interest, if the loan is to an independent entity and the interest rate + points is commercially reasonable. Also, I wouldn't share more than 50% equity pursuant to a a shared equity provision of the loan. Convincing the IRS that a reasonable person would accept their lender taking 80% of their profit would be mighty difficult.
Quote:
What's the difference between that and buying stock, holding it and then getting the money back - why isn't that dealing?
Buying and selling stock isn't dealing because you have no customers per se when selling on the open market, and you have no real control over your buy/sell price.
Quote:
And what if I buy options? Options are almost always short term - wouldn't that also be considered dealing, even though it's a portfolio activity?
Yes it would. Flipping notes is the same way.