I am contemplating a Private Equity investment from my IRA. The investment will be a membership interest in an acquisition LLC which will acquire a 100% interest in an operating business also an LLC. The operating business will issue K!'s to the investement LLC. The investment LLC will issue K1's to the investors. Will the income from the acquisition LLC be subject to UBIT in my IRA?

asked 01 Oct '10, 21:46

Bob's gravatar image

Bob
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If you are considering using a self-directed IRA to invest in non-standard assets you should consult with a tax professional to analyze the LLC's facts and circumstances. Whether the LLC would generate unrelated business taxable income (UBTI) or unrelated business income tax (UBIT) depends upon what the LLC invests in.

A self-directed IRA may not invest money in life insurance, collectibles, or investments that involve a disqualified person (certain close or related parties). Most "passive" type investments do not generate UBTI, such as interest income, dividends, real estate rental, and the proceeds from the sale of real estate held for investment. However, business income could subject an IRA to UBIT such as income earned from the sale of a product or service. If your IRA buys a gas station and earns its income from the convenience store and the sale of gasoline, then it is conducting a business.

Where self-directed IRAs often encounter UBTI is with projects that involve real estate development and construction for resale.

The IRS uses several factors to determine if an activity is a passive investment or a business activity. No single one of these factors is more important that the others, and no one factor is determinative. Here are some of the most common tests:

Intent – what did the investor intend to do with a property? Development and construction – what was the scale and intention of such development? Holding Period – the longer a property is held, the more likely it is just an investment.
Marketing – Aggressive or business-like marketing can create UBTI.
Inventory Replacement – the more quickly you buy and sell properties, the more you appear to be a real estate developer that creates UBTI.

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answered 02 Oct '10, 18:51

Bill-EA's gravatar image

Bill-EA
3.9k2720
accept rate: 3%

Hi Bob,

Bill is right. When it comes to self-directed IRAs and operating businesses, you open yourself up to sooooo many ways to get the IRA disqualified.

While Bill suggested you work with a tax pro, I doubt many are really familiar with how this works. So you will need to do some shopping and interviewing.

I set up a self-directed investment for a client quite some time ago, working with an experienced attorney. Well, he literally disappeared off the face of the earth halfway through the process. Hasn't been heard from since. So, that's another danger.

However, I have found a really reliable, well-informed team here - www.nafep.com Their attorneys do understand the issues and can work with you to either structure the investment so it works, or tell you why it won't.

Good luck.

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answered 07 Oct '10, 12:25

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TaxMama
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accept rate: 11%

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Asked: 01 Oct '10, 21:46

Seen: 1,593 times

Last updated: 07 Oct '10, 12:25