If you’re looking for a tax break this year, there’s still time to open a Solo 401(K). But do your research and seek experts to help you understand the plan, how to manage your account without the need for a custodian which amounts to extra fees, and how to transfer your existing new plan. You’ll find the options for investing and maximizing your contributions are plentiful but the clock’s ticking—you only have until December 31st to open one for 2009.
Self Directed Solo 401k vs. 1031 and other conventional RE tax strategies
February 24, 2009 By 1 Comment
Conventional Tax Strategies for Real Estate
Many real estate investors boast of their tax strategy as involving one or more of the following:
Depreciation – This is a tax concept where the property owner pretends that his property is decreasing in value. For residential real estate, it assumes that the property’s improvements will become worthless over 27.5 years. In commercial real estate, the calculation is for 39 years. During each year of property ownership, the owner can take that year’s pro rata depreciation as if it is a loss against the income of the property… which reduces the taxable income of the property, thus reducing the amount of taxes due. Upon future sale of the property, depreciation normally must be “recaptured” which means that there is no more pretending, and the taxes on the truly realized gains must be paid anyways.
Cash out Refi – This is where the owner of the property will refinance the mortgage. The new loan will have a higher balance than the old one, resulting in “cash out”. Because this is just borrowing, it is not a taxable event. Upon future sale of the property, however, taxes will normally be due on the actual gains anyways.
1031 Exchange – Upon the sale of real property, the gains can be deferred if they are used to purchase property of “like kind” within a certain time period. It goes something like this:
- Sell Property A
- Have a “qualified intermediary” receive the proceeds of the sale
- Replacement property (“Property B“) must be identified in writing within 45 days of the sale of Property A
- Property B must be purchased (closed) within 180 days of the sale of Property A
- Property B must be of equal or greater value to Property A
- Both properties must be “like kind”. For instance if Property A was U.S. real estate, Property B must also be U.S. real estate.
So, savvy real estate investors often [Read more...]
Unrelated Business Income Tax – UBIT for Solo 401(k) & IRA accounts
February 19, 2009 By 6 Comments
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: [Read more...]
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