(depending on the amount of the tax you may be required to make quarterly payments). Failure to timely file and pay the tax will result in the following penalties: INTEREST // This includes interest charged on taxes not paid by the due date and interest charged on penalties imposed for failure to file, negligence, fraud, substantial valuation misstate- ments and substantial understatements of tax from the due date (including extensions) to the date of payment. LATE FILING OF RETURN // Failure to file Form 990-T for other than reasonable cause may subject your IRA to a penalty of 5 percent per month of the net amount due, up to a maximum of 25 percent. The minimum penalty for a return that is more than 60 days late is the smaller of the tax due or $135. LATE PAYMENT OF TAX // A penalty for late payment of taxes is usually half of 1 percent of the unpaid tax for each month or part of a month the tax is unpaid. The penalty cannot exceed 25 percent of the unpaid tax. PENALTY FOR NOT FILING QUARTERLY // A penalty is assessed against IRAs that do not file quarterly estimated tax payments in the same manner as a corporation. In other words, after the first 990-T is filed, the IRA must make pay- ments every three months. To file a 990-T, your IRA must obtain a federal tax ID number (“EIN”). Not only will you need this number for tax reporting, you will also need it if you plan to invest in a partnership, LLC or other entity required to file a tax return, purchase promissory notes, engage in private lending, or issue or receive 1099s, 1098s or K-1s. Most self-directed IRA investors are unaware of their respon- sibility to file. Some operate under the assumption their custo- dian is responsible for handling all reporting. I must disabuse them of their belief because their custodian is not in the position to have all the information necessary to file the 990-T. Most self-directed IRAs are set up with an LLC to give the account holder “checkbook control,” and as a result, all investment paper- work is sent to the IRA account holder. The good news is these problems can be easily addressed and corrected with the right support and front-end advice. • Clint Coons is a founding partner of Anderson Law Group and current manager of the Washington state office of Anderson Advisors, a legal, business and tax specialty company. Real estate investing is a major focus of his practice. A noted author and presenter on asset protection and tax reductions, Coons has gained national recognition as an expert in his field and is noted for his ability to take a complicated law or structure and explain it in clearly understandable terms. For more information, visit www.andersonadvisors.com.
the same activity is taking place in the IRA that is carried on outside by the account holder. If UBTI wasn’t enough of a concern, you also need to be up to speed on “unrelated debt-financed income” (UDFI). UDFI occurs when your IRA receives (either directly or indirectly through a “flow-through” entity, like an LLC) income from “debt-financed” property. Consider Kevin, who set up a self-directed Roth IRA and rolled over $80,000 from his traditional Roth. Kevin wanted to use his funds to purchase a rental house. With the help of a fellow investor and his IRA custodian, Kevin bought a rental property in Las Vegas for $200,000. Kevin was able to make the purchase with the assistance of an unrelated lender who loaned Kevin’s IRA $120,000 on a nonrecourse basis. (A nonrecourse loan is one where the lender can only look to the asset itself for recovery in the event of default, i.e., no personal guarantee.) Kevin’s first-year rental income, after expenses, was $20,000. Kevin was ecstatic with his tax-free return until he spoke with his CPA, who informed Kevin his Roth IRA must pay $2,000 in tax on the income. Kevin was confused; he thought Roth IRAs
were supposed to be tax-free. Unfortunately for Kevin, his IRA custodian did not explain the rules to him; the use of debt inside of an IRA is a taxable event. Kevin’s situation is not unlike those of many real estate investors who have used their self-directed IRAs to purchase real estate using nonrecourse financing. When an IRA uses debt for a purchase, the debt-fi- nanced portion of the investment is taxable
to the IRA at the trust tax rates mentioned earlier. In Kevin’s situation, he borrowed $120,000 to make a $200,000 purchase. Therefore, 60 percent of the acquisition cost was attributed to debt. Thus, $12,000 of the $20,000 in annual income is taxable to Kevin’s IRA. Further, when Kevin later sells the property, his IRA will pay tax on the debt-financed portion of the gain. Using debt inside an IRA will allow you to make more and larger deals, but it comes at a cost: high taxes. Also, consider that if your self-directed IRA is not a Roth, then you will be taxed a second time on your money when it is withdrawn. Often, real es- tate investors using debt inside their IRAs end up paying over 45 percent in taxes on their income. (Note that expenses attributed to the property, e.g., depreciation, management fees, etc., are de- ducted against your income in calculating the taxable amount.) IRA TAX FILING If you think you have engaged in a transaction resulting in possible UBTI or UDFI, it is important you bring your tax filing into compliance sooner rather than later. IRAs with taxable income must file Form 990-T by April 15 and pay any tax due
116 | think realty magazine july :: august 2016
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