George L., a client of American IRA, LLC, wanted to purchase a 56 unit, 1.2 million dollar mobile home park inside his IRA account.
George was determined to make this dream a reality and worked hard in negotiations with the owner of the mobile home park finally settling on these details:
- Purchase price $1,200,000
- Down Payment $200,000 from an old 401(k) plan
- Owner financing $1,000,000 at 6% interest
A Word of Caution about Loans inside an IRA
The American IRA account specialist informed George that the owner financing needed to be “non-recourse” to qualify for IRA financing.
The account specialist explained further that “non-recourse” means the property is the only collateral; neither George L. nor his IRA can be held liable.
George went back to the table with the owner and was able to negotiate non-recourse terms for the owner financing.
George is Self-Employed – Why Does That Matter?
It is important because George L.’s self-employed status means he qualifies for a Solo 401(k).
Even though a self-directed IRA and a self-directed Solo 401(k) work in a similar fashion, there are some significant differences.
- UDIT applies to an IRA and does not apply to a Solo 401(k) on purchase money debt.
- This saves thousands of dollars that will stay in the Solo 401(k) and grow tax free.
- Purchase money debt is debt that is originated ‘at the time of purchase’.
- If George L. adds a second mortgage to the Solo 401(k), the second mortgage WILL be subject to UDIT.
- The American IRA account specialist explained the differences to George L. and then asked him to meet with his professionals to determine whether a self-directed Solo 401(k) was the right tool for him.
- George L. met with his professionals and decided a Solo 401(k) was the right tool for him.
Living the Dream!
George L. successfully completed the transaction purchasing the mobile home park. George was now the proud owner of his 1.2 million dollar, 56 unit mobile home park!
Time to Refinance?
In January 2012, George L. told his professional that interest rates are low and that he was thinking of refinancing the mobile home park that was held by the Solo 401(k).
- George kept in mind that
- The loan had to be non-recourse
- He needed to consult with a tax specialist because he would lose the exclusion from UDIT on any refinance of the mobile home park.
- He needed to determine if the interest savings was worth the UDIT that would now be due on a balance of $850,000.
- George L. met with his tax specialist and decided not to refinance.
The IRS allows an IRA to borrow money, however the borrowed money is not part of the retirement plan so there is a tax assessed call UDIT. UDIT applies only to the borrowed portion of the transaction. (As mentioned earlier purchase money debt inside a 401(k) is exempt from UDIT).
Example: 100,000.00 purchase price 60,000.00 from the Ira and 40,000 from a non-recourse loan. The UDIT income tax is assessed only on the 40,000 that was borrowed after taking all the normal deductions that are available to real estate investors, such as depreciation, interest, maintenance etc.
Now you may be thinking, ‘Why do I want to pay taxes inside my IRA?’ There are three reasons to subject your IRA to UDIT:
- Leverage is the key to real estate investing.
- All profit made outside an IRA are taxed at every level.
- Profits inside the IRA will compound tax deferred or tax free depending on the type of account you have until they are distributed at the age of 59 ½.
American IRA, LLC does not give investment advice. They do offer guidance as to the rules and regulations related to their self-directed accounts and the benefits of different account types so that their clients can take that information to their professionals to discuss the ramifications of various decisions on their individual situation.
For more information, or to explore your options, call American IRA today at 866-7500-IRA (472). We look forward to working with you.