another real estate investment question

[Gudgergirl]

Client has $400k in an IRA and wants to invest it in real estate. The real estate in question costs $600k. If the IRA borrows $200k to buy the real, it will have UBTI.

Client has the $200k but is prohibited form lending it to IRA under the prohibited transaction rules.

Can client and IRA simply purchase the property together (or form an LLC to purchase the property)?

[Guest FISS]

Client has $400k in an IRA and wants to invest it in real estate. The real estate in question costs $600k. If the IRA borrows $200k to buy the real, it will have UBTI.

Client has the $200k but is prohibited form lending it to IRA under the prohibited transaction rules.

Can client and IRA simply purchase the property together (or form an LLC to purchase the property)?

Gundergirl:

Let me preface with a recommendation to consult an attorney or CPA for full details on UBTI. However, my understanding is that the mere use of a loan to the IRA to purchase property does not generate UBTI or specifically, Unrelated Debt Financed Income (UDFI), but any income associated with the property is taxed (i.e. rental income) based on the net income of the property (after expenses such as interest expense, maintenance, depreciation, etc.) attributable to the financed portion (i.e. initially 33% in your example-200k/600K). There is also an exemption of the first $XX (I think it's $1000) of income. Quite often, UDFI is less of an issue than generally perceived. Also, at time of sale, any gain (based on the then financed portion) is taxed under UBTI/UDFI rules. However, if the loan is paid off 12 months prior to sale, then no tax on gain at time of sale. Please note that a property is not depreciated per se in an IRA, but "phantom" depreciation may be used to determine net IRA income on the property for the purposes of UDFI.

Finally, a property can always be purchased through a Tenant-in-common ownership structure which could be utilized to purchase the property as 2/3 IRA ownership, 1/3 other ownership (personally, other qual plan, other investor). However, one must be VERY careful to maintain accurate records to ensure that all income/expense is allocated appropriately and that no prohibited transactions occur (i.e. the IRA owner performs maintenance personally, or uses the real estate for persona use). And, a tenant-in-common ownership structure negates the need to establish an LLC simple to manage group ownership.

PM me if you would like any additional info.

[jpod]

The mere co-investment between an IRA and the IRA owner, or a family member of the IRA owner, could be a pt under Section 4975 of the Code.

[J Simmons]

The mere co-investment between an IRA and the IRA owner, or a family member of the IRA owner, could be a pt under Section 4975 of the Code.

I agree with jpod. Get a legal opinion on the pt question before proceeding.

[Guest Rajeev]

Gudgergirl,

IRA Owner cannot lend money to the IRA --- Prohibited Transaction.

Just the mere fact that the IRA owner and the IRA are acquiring a property as tenants in common is NOT a prohibited transaction, but prior to executing the transaction, one has to look at another "enabling rule", which in the example that you have provided before "Can the IRA complete the transaction without the use of the IRA Owner's (outside IRA money) help?".... If the answer is yes, then it is NOT a prohibited transaction, else it is a prohibited transaction.

This has been made apparent with the Tax Court Case "Swanson vs. Commissioner - Dkt. No.21203-92 in Feb 1996).

Hope this helps..

[ESOP Guy]

My father found a house for sale near him. He thinks it would be a good investment. He was thinking of bringing my brother and myself into the deal. Currently, the best place for me to get the funds for this would be my wife’s IRA.

From what I am seeing here it would be safe to say this is a high risk concept because of the PT rules.

Can this be done?

I have done some reading. Would forming an LLC and having the IRA buy the 100% of the LLC and then having the LLC be a partner in the venture help at all?

My guess is no. The IRS if nothing else can look beyond the form to the substance of any deal and the substance of the deal is still a PT.

But I thought it was worth asking people here.

As an aside he is much older than my brother and myself. Assume we hold the house until he passes. Would my inheriting a portion of his share be an added PT issue?

I suspect while it comes with its own set of problems the real answer would be to take a loan from my 401(k) account and just buy into my portion of the deal.

[Jim Norman]

I agree with the others that the TIC purchase with the IRA is potentially a PT.

One must also remember that the penalty for IRA PTs is DEATH. The whole IRA is deemed distributed and taxable when the PT occurs. This is an area where an abundance of caution is warranted.

[Guest Sieve]

At a minimum, rollover sufficient assets into a new IRA to invest in the real estate. If it's a PT, then only the IRA invested in the real estate is at risk (rather than all your IRA assets). But get4 good legal advice before moving forward, so that you fully understand what you're getting into.

[mbozek]

My father found a house for sale near him. He thinks it would be a good investment. He was thinking of bringing my brother and myself into the deal. Currently, the best place for me to get the funds for this would be my wife’s IRA.

From what I am seeing here it would be safe to say this is a high risk concept because of the PT rules.

Can this be done?

I have done some reading. Would forming an LLC and having the IRA buy the 100% of the LLC and then having the LLC be a partner in the venture help at all?

My guess is no. The IRS if nothing else can look beyond the form to the substance of any deal and the substance of the deal is still a PT.

But I thought it was worth asking people here.

As an aside he is much older than my brother and myself. Assume we hold the house until he passes. Would my inheriting a portion of his share be an added PT issue?

I suspect while it comes with its own set of problems the real answer would be to take a loan from my 401(k) account and just buy into my portion of the deal.

Its possible if the IRA funds are invested in a family limited partnership (FLP) with non IRA assets. FLPS are complex estate planning vehicles operated as a partnershp to invest family money that need lots of legal and tax advice. There is a DOL opinion letter about 10 years ago approving a FLP where one of the limited partners was an IRA account. When you find it check out the investment manager to the FLP.

Edit: The DOL opinion is 2000-10A