Today we're joined by Brian Eastman, principal and Sr. Consultant at Safeguard Advisors. Safeguard Advisors is an innovative provider of Self-Directed retirement plans for individuals and entrepreneurs who want to take control of their own wealth building future - specifically establishing Checkbook IRA and Solo 401(k) plans.

When Does a Self-Directed Plan Need to be Concerned for Tax Exposure?

With self-directed plans, there are generally two taxation-generating activities:

1) Using debt financing, or leverage, creates unrelated debt financed income.

2) Separately, when a tax-exempt entity is acting like a trade or business and earning income, this results in unrelated business taxable income.

These both result in UBIT - Unrelated Business Income Tax.

UDFI - Unrelated Debt Financed Income

UDFI is generated when a tax-exempt entity is using non-plan funds to accelerate growth, using these funds to enable investment. 

UBTI - Unrelated Business Taxable Income

This applies when a tax-exempt entity is engaging in a trade or business on a regular or repeated basis. When acting as or competing with other commercial enterprises, this income will be treated as such.

Interplay with Real Estate Syndications

By nature, this activity won't create UBTI. Rent from real property is passive - not considered trade or business income. As long as it's rent from real property, we're not worried about UBIT. Many of these larger deals are debt financed, which generates exposure to UDFI. For example, If 75% of the investment is debt-financed, 75% is viewed as UDFI and is taxable. This ratio is always equal to the percentage financed by debt, and the ratio applies to expenses too. There's also a $1,000 exemption right off the top.

This net taxable figure is ran through the trust tax table, being taxed at different rates than ordinary income.

Exemption for UDFI

There are two types of Self-Directed retirement plans. The majority of individuals use IRAs.

For self-employed individuals with no full-time employees, there is an Individual or Owner-Only version of a 401(k) available. In a narrow case, there is an exemption from UDFI when the finds are used to purchase a property or invest in an entity that will be purchasing property. If you qualify, this is a more favorable vehicle. Forcing a qualification is not a good move, as the tax difference will be minimal compared to the consequences of forcing qualification for this plan when it doesn't exist.

Transferring from a Self-Directed IRA to a Solo 401(k) or Vice Versa

In most cases, these vehicles are compatible with each other. Assets must be re-titled and other smaller considerations, but, in general, movement is allowed between the two.

Rents from real property may be exempt from UBIT because they're deemed to be passive income. Other industries, such as self-storage and hotels, are considered services and are not included in real property rental income.

Alternative Approaches

The point of an alternative approach would be to have the activity be considered passive. The bank could be the intermediary here, where money goes through the bank to allow you to fund flips, for example. The other route is a "hybrid-flip". The buying of the property is not what triggers the activity - it's the sale. If the property is flipped and rehabbed, yet it's held for rent instead for at least 12 months, this is considered passive and results in a tax-sheltered return.

Learn more about Brian and his work: www.ira123.com

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