Where to find a nonrecourse loan for a Self Directed Solo 401(k)

Jeff Nabers — Mon, 23 Mar 2009 18:13:58 +0000

For many real estate investors, leverage is a key factor to their plans for profits – leverage in the form of mortgage financing. When you introduce mortgage financing into Self Directed IRA ownership of real estate, a special tax called Unrelated Business Income Tax (UBIT) is triggered. The tax often isn’t detrimental as will be covered in another post, but nonetheless it reduces the profit.

For the self employed, a fantastic development has occurred over the past few years – the Solo 401(k). One distinct advantage of the Solo 401(k) over an IRA is that it is not subject to paying UBIT on profits from financed real estate. Eliminating UBIT by using a Solo 401(k) eliminates the need to file a return (Form 990-T) as well as the accompanying tax. Sound pretty good so far?

The difficulty in recent times has been obtaining nonrecourse financing. The leader of NR financing in the Self Directed IRA industry for the past few years has been North American Savings Bank. Last year, they took the familiarity of IRA lending and applied it to Solo 401(k). Unfortunately for many Solo(k) investors, this has only been available to plans who choose to name a custodian as trustee of the plan. Qualified plans (which is what all 401k plans are) are different than IRAs in that they are not required by law to name a custodian (bank or trust company) as trustee of the plan assets. Investors who establish Self Directed Solo 401(k) plans that name themselves as trustee for simplicity have not been able to readily obtain mortgage loans for their Solo (k) plan from NASB.

Well, as of this month, NASB has expanded their loan products to include a nonrecourse loan program for self trusteed Solo 401(k) plans. I caught up with Matt Allen to discuss the great news on UNLIMITED RETIREMENT ACCOUNT® Radio. The skinny is that the program is almost identical to the IRA lending program. If you aren’t familiar with their guidelines, check out the URA Radio show podcast as it become available soon.

Subscribe :: del.icio.us :: Digg this :: Stumble it :: facebook

:: :: :: :: :: :: :: :: [What are these icons for?]

Unrelated Business Income Tax – UBIT for Solo 401(k) & IRA accounts

Jeff Nabers — Thu, 19 Feb 2009 15:52:09 +0000

If you talk to the average CPA, he’ll tell you that UBIT is the boogeyman and is to be avoided… always. Discussing this topic with an above average CPA (such as Eric Wikstrom of Integrated Wealth Strategies) yields different advice.

The Two Types of UBIT

Triggered from a trade or business – if a tax exempt entity (such as an IRA or 401k) owns a trade or business, the income of that business is taxed at trust rates (i.e. very high tax rates). Both IRA & Solo 401k accounts are subject to this type of UBIT.
Triggered from ownership of leveraged real estate – if a tax exempt entity (including IRA) owns real estate leveraged with a mortgage loan, the portion of that income attributable to the mortgage loan is taxed at trust rates. This type of UBIT is specifically referred to as UDFI – Unrelated Debt Financed Income. Solo 401k accounts & other qualified plans are exempt from UDFI.

Trust tax rates are very high, so it might make sense to avoid Type 1 UBIT at all costs. On the other hand, a close examination of UDFI tends to revoke its “boogeyman” status.

The reason UDFI isn’t a detrimental cost is that non-recourse mortgage loans (the only type an IRA/401k can legally obtain) are typically only offered at a 65% loan-to-value maximum. So this means that the UDFI tax is only payable on up to 65% of the property’s net income. (That’s right – net income. You do get to deduct depreciation and other expenses before paying UDFI tax).

Let’s examine a simple comparison of the taxes payable on net real estate income with 50% leverage:

Example A

	IRA	Individual
Net Income	10,000	10,000
Tax Paid	800	2,800
Effective Tax Rate	8.00%	28.00%

Example B

	IRA	Individual
Net Income	100,000	100,000
Tax Paid	16,229	28,000
Effective Tax Rate	16.23%	28.00%

The gap between the dollar amount of taxes paid widens as the income increases:

Let’s go back and look at Example B. Take the difference in taxes and examine the long term effects of 25 years of investing and compounding returns. These charts assume a 15% annualized ROI:

Example B1

This uses an effective tax rate of 16.23% for UDFI

Example B2

This uses an individual tax rate of 28%

The result? The IRA has a balance of $631,385.87 more than the individual does.

Conclusion