You don’t have to leave your 401(k) or other employer retirement plan money in an existing plan if you no longer work for that employer. The same rule applies to an inherited 401(k) or employer retirement plan. Whether it’s your plan or it’s inherited, you can legally and advantageously move those funds into an IRA where either you or your financial adviser can invest and manage the money much more effectively with a self-directed IRA from AET. This is called a roll over IRA. There are no penalties or taxes to pay for correctly handled roll over accounts. To see some of the far more beneficial things you can do with an IRA which you can’t do with the employer plan, Click Here.

Pre-Tax 401k Contribution Limits

2010 – $16,500
2011 – $16,500 plus an index for inflation ($500 increments)

Pre-Tax 401K Catch Up Limits

For plan participants that reach age 50 before the calendar year is over to make additional catch up contribution limits on a pre-tax basis as shown below:

2010 – $5,500
2011 – $5,500 plus an index for inflation ($500 increments)

Employer Contribution Limits

In addition to the contribution limits appearing in the tax law, there can be employer imposed contribution limits to 401k plan.  The contribution limit for employers is set at 6% of the employee’s pre-tax compensation.

That means an employee with a total compensation package of $100,000 can contribute $16,500 in 2010 on a pre-tax basis and their employer can contribute another $6,000 for a total of $22,500.  If you’re 50 or older, then you can contribute another $5,500 pre-tax bringing the total to $28,000.

This is our latest educational/promotional video detailing the Self Directed IRA.

Offering a simple diagram explanation of how the Self Directed IRA with Checkbook Control works, and provides a simple example of a SDIRA Real Estate Transaction.

This is a preview of the new Self Directed IRA video produced by me here at NAFEP. This is just a simple intro, with no real substantial information available. The full video will be considerably more enlightening I promise!

UPDATE The FULL video is finally available!

SEE IT HERE

A subset of UBIT is the Unrelated Debt-Financed Income (UDFI) tax. Under IRC § 514, the IRS will assess a tax on any income that is derived from the use of “acquisition indebtedness” in passive Self Directed IRA investments. For example, if your Self Directed IRA uses $30,000 of its own funds and also borrows $70,000 (using a non-recourse note, of course) to purchase a $100,000 rental property that generates $10,000 annual rent, the IRS would assess UDFI tax on about $7,000 of the profit (since 70% of the investment came from leverage). It is “about $7,000” because it is not simply a one-time fraction of loan-to-value. When calculating your UDFI tax percentage, you use the average indebtedness of the past 12 months and divide that by the adjusted basis in the property (typically, the original purchase price). So, as you pay down the mortgage each year, the UDFI tax percentage becomes less. One year after paying your final mortgage payment, the UDFI tax disappears altogether. When selling passive investments for a profit, the UDFI fraction will determine the taxable amount. Then, appropriate capital gains rates are applied to that amount (trust rates for short-term gains; capital gain rates for long-term gains. [See IRS Pub. 598.]

Remember that UDFI rules apply only to passive investments. If your IRA makes an investment, regardless of leverage, in an active (pass-through) business, including any active real estate business (flipping, rehabbing, developing raw land, etc), then the net income (above $1,000) is subject to UBIT.

Disclaimer

This brief discussion of prohibited transactions and UBIT/UDFI is not intended to be relied upon as legal or tax advice. It is very general information and is designed only to make you aware of some issues you might not have thought of and may need to discuss with your advisors. These rules can be very complex. Some of the rules have exceptions (and even exceptions to the exceptions!) and rules can and do change

This is an important topic because many people, especially those who have never had a self-directed ira, are unaware of the tax treatment for certain types of investments. UBIT was never an issue when investing in the set of mutual funds, or individual stocks, offered by a brokerage IRA account. Such investments simply earn dividend income or capital gains and are therefore passive investments. The corporations making these dividends to shareholders have already been taxed on their business profits prior to making dividends. Your IRA is allowed to escape the double taxation that other shareholders pay when receiving dividend income (although you will be paying ordinary income taxes on those profits when you later receive distributions from your IRA).

Active investments, on the other hand, receive their income as business profits, not as passive dividends. If you were to personally invest your own money as a sole proprietor or partner in an active trade or business, you would receive self-employment income or partnership distributions which are taxed to you personally. If your self directed IRA makes the same investment and, for example, becomes a partner in an active business, it would theoretically avoid all taxation. The pass-through income would not be taxed at the business level nor at the IRA level (at least not immediately and for Roth IRAs, never).

Naturally, the IRS had a real problem with this! Congress was concerned that this might provide an unfair advantage to exempt entities competing against private businesses that have to deal with taxes. Exempt entities were supposed to avoid taxation only on the activities related to their charitable function, not on unrelated side businesses that could generate additional tax-free revenues for the entity. To remedy the difference, IRC §§ 512-513 were enacted to require exempt entities, including your self directed IRA, to pay a tax on the earnings received from any unrelated active (pass-through) businesses. This tax is known as the Unrelated Business Income Tax (UBIT). It is taxed at the same rate as trusts, which have the same brackets as individuals. However, it should be noted that trusts reach the maximum bracket much quicker (at a much lower income level) than do individuals or corporations. There also could be UBIT incurred at the state level and state law might not provide the same passive investment exemptions to UBIT that federal tax law provides so you should consult your tax advisor about your state tax issues.

Any active trade or business is, by definition, unrelated to the function of a retirement account so all retirement accounts would normally pay this tax when they invest in any trade or business.

Fortunately, there are a few exceptions to UBIT for your Self Directed IRA. It can avoid federal UBIT if its investment income comes from these passive sources:

1. dividends (from C corporation shares);
2. royalties (special rules apply to royalties from mineral interests);
3. interest from passive loans
4. rents from real estate, and any related rent from a small amount of personal property (defined as 10% or less of the total rental income);
5. capital gains/losses on the sale or exchange of unleveraged equity interests in a business (whether a passive investment in stock or an active investment in a pass-through entity);
6. gains/losses from the lapse or termination of options to buy/sell securities or real estate; and
7. gains/losses from the forfeiture of good-faith deposits for the purchase, sell or lease of real estate in connection with the entity’s investment activities.

Note that certain rental income is still subject to UBIT, including:

• if rent is tied to the income of the tenant (such as with some shopping centers that charge a flat rate plus a percentage of sales)
• hotel rooms
• boarding houses
• tourist camps
• storage or warehouse space
• certain parking lot income

Many self-directed ira account holders will be satisfied with having the option to invest in real estate, precious metals, or similar passive investments and earn a better-than-the-stock-market rate of return. Such accounts are unlikely to generate UBIT. However, if you are interested in “rehabbing/flipping properties” or developing raw land, then this would likely constitute the running of an active business by your self directed IRA and the net profits (above $1,000) would be subject to UBIT. Also, if your IRA is a partner in an active (pass-through) business venture, the net income generated (above $1,000) will be subject to UBIT. The only way to avoid paying UBIT is to limit your account to the passive investments described above.

Having said all this, paying UBIT is not the end of the world! There might very well be a potential investment that provides a substantial after-tax return on investment.

For example, which investment would you prefer?

(1) a mutual fund, which does not incur UBIT, and provides an untaxed 10% return

– OR –

(2) a real estate investment business (rehabbing/flipping properties), which incurs UBIT, but still provides an after-tax return of 25%

It’s easy to see that having to pay UBIT, by itself, should not be a deal killer. You can run the numbers and determine for yourself which opportunities have the best net returns. The thought of your self directed ira paying any taxes is troubling to some but being able to stash away a large amount of funds and to help those funds grow at a higher rate than what the stock market provides is why self-directed IRAs are becoming so popular. You may have expertise in certain activities or industries and can determine which investments might be able to provide the best profits. The potentially substantial growth of your IRA may be well worth paying UBIT when necessary. Be sure to ask your advisor about state tax issues as well.

Disclaimer

This brief discussion of prohibited transactions and UBIT/UDFI is not intended to be relied upon as legal or tax advice. It is very general information and is designed only to make you aware of some issues you might not have thought of and may need to discuss with your advisors. These rules can be very complex. Some of the rules have exceptions (and even exceptions to the exceptions!) and rules can and do change periodically. You must consult with your own independent legal and tax advisors to verify the accuracy of this information and determine the best course of action for your investment objectives and strategies.

Even though there are not any bright lines as to when buying and selling real estate through your self directed IRA would constitute UBTI, the general guidelines will be based facts and circumstances. Some of the factors that would be used to determine if the real estate transactions would meet the requirement for UBTI are:

• The purpose for which the property was acquired
• The frequency, continuity and size of sales
• The extent of improvements
• The activities of the owner in improving and disposing of the property
• The purposes for which the property was held
• The proximity of purchase and sale (i.e. how close together were the transactions)

In general we advise clients that flipping or turning one property may or may not meet the UBTI standard. However, if you show a routine pattern of buying and selling property and if there appears to be the intent of turning properties for profit, then you will most likely be subject to UBTI.

For more information on self directed IRAs go to:

www.iracentral.com

www.nafep.com

Another common scenario is that someone is a good money manager or investment guru type and they want to bring in or combine several family member’s IRA account and manage it as a pool. In exchange, the money manager (a related and disqualified party) wants to earn fees or commissions from their activities. In this case the money manager is a disqualified party, and they receiving a direct benefit from the IRA accounts of disqualified persons. This clearly would not be allowed.

A disqualified person can be paid reasonable fees and expenses for providing services to the IRA. Such an example could be that your spouse is a CPA and your self directed IRA LLC hires your spouse to do tax work. There are not any clear lines as to what constitutes reasonable. So, our position on any transactions with any disqualified party is just don’t do it!

As tempting and harmless as some of these transactions appear to be, we feel its better to steer clear of having to potentially defend your actions in the event of an audit.

These scenarios and opinions expressed above are for informational and educational purposes and are not intended to be an exhaustive list of scenarios. If you feel your situation may have an exception or you require a more definitive opinion then you should contact your personal tax advisor.

To learn more about self directed IRAs go to:

www.nafep.com

www.iracentral.com

Regardless of how involved the self directed IRA account owner is in the business, the business is active and it is competing against other businesses that are required to pay taxes. As such, the IRA would be subject ti UBTI tax regardless of the account owners involvement in the business.

To learn more about self directed IRAs go to:

www.nafep.com

www.iracentral.com

However, a prohibited transaction or indirect benefit line could be crossed if the self directed IRA owner (or as the IRA LLC manager) were to use their personal tools and equipment to improve the property (e.g. use your saws, materials, truck, employees, to add a new roof). Another potential mistake is the self directed IRA owner provides all of the labor for making the improvements.

The general rule of thumb is that you are allowed to provide the necessary care and management of the self directed IRA’s assets, but you should draw the line at providing “sweat equity” or use and benefit of your personal assets.

To learn more about self directed IRAs go to:

www.nafep.com

www.iracentral.com