Self Directed IRA & Lawyer Question

I've got none of that experience...but I'll be fascinated to hear the discussion and any recommendations!

Jim

We've done it and it's a PITA! Unless you are doing long-term rental of your property, any rental income is considered UBTI and taxes must be paid. Unless you are living here, managing and maintaining the property yourself, you won't really make any money! By the time you pay a property manager, housekeeper, HOA if it's a condo, pool service, landscapers, and security if it's a villa, you won't make enough to make it worth it! And for the most part, properties here are not really appreciating. Here in Las Terrenas, there are always new and sexier properties being marketed, so resale prices are pretty stagnant.

We were fortunate to have an apartment covered by CONFOTUR, so we didn't have to pay any Dominican taxes on rental income or property taxes, but we still have to pay the 1% of assets tax on businesses in DR..

We used Guzmán Ariza to register the US LLC to do business here in DR. John Hyre was our tax attorney in the US for all things self-directed IRA. I don’t know that I would recommend them - once they did the initial groundwork, getting responses to questions was almost impossible.

Great answers!  Thank you!

@ddmcghee

Thanks so much for the feedback!!! I may reach out. I found Ariza as well

@ddmcghee

I believe UBTI is only if financing. I am paying cash

@dougdanakids

“UBIT also applies to an IRA that uses debt to buy an investment, such as a loan on a real estate property. The income attributable to the debt, known as Unrelated Debt Financed Income”

@dougdanakids

not a simple thing lol

Tip 1: “When Does UBIT Apply?”

UBIT applies when your IRA receives “unrelated business income”. However, if your IRA receives investment income, then that income is exempt from UBIT tax. Investment income that is exempt from UBIT includes the following.

Investment Income Exempt from UBIT:

Real Estate Rental Income, IRC 512(b)(3) – The rent of real estate is investment income and is exempt from UBIT

Interest Income, IRC 512(b)(1) – Interest and points made from the lending of money is investment income and is exempt from UBIT.

Capital Gain Income, IRC 512(b)(5) – The sale, exchange, or disposition of assets is investment income and is exempt from UBIT.

Dividend Income, IRC 512(b)(1) – Dividend income from a c-corp where the company paid corporate tax is investment income and exempt from UBIT.

Royalty Income, IRC 512(b)(2) – Royalty income derived from intangible property rights such as intellectual property and from oil/gas and mineral leasing activities is investment income and is exempt from UBIT.

There are two common areas where self-directed IRA investors run into UBIT issues and are outside of the exemptions outlined above. The first occurs when an IRA invests and buys LLC ownership in an operating business (e.g. sells goods or services) that is structured as a pass-thru entity for taxes (e.g. partnership) and that that does not pay corporate taxes. The income from the LLC flows to its owners and would be ordinary income. If the company has net taxable income it will flow down to the IRA as ordinary income on the k-1 and this will cause tax to the IRA as this will be business income and it does not fit into one of the investment income exemptions.

The second problematic area is when IRAs engage in real estate investment that do not result in investment income. For example, real estate development or a number of significant short-term real estate flips by an IRA will cause the assets of the IRA to be considered as inventory as opposed to investment assets and this will cause UBIT tax to the IRA.

Tip 2: UBIT Applies When You Have Debt Leveraging an IRA Investment

UBIT also applies to an IRA when it leverages its purchasing power with debt. If an IRA uses debt to buy an investment, then the income attributable to the debt is subject to UBIT. This income is referred to as unrelated debt financed income (UDFI) and it causes UBIT. The most common situation occurs when an IRA buys real estate with a non-recourse loan. For example, lets say an IRA buys a rental property for $100,000 and that $40,000 came from the IRA and $60,000 came form a non-recourse loan. The property is thus 60% leveraged and as a result, 60% of the income is not a result of the IRAs investment but the result of the debt invested. Because of this debt, that is not retirement plan money, the IRS requires tax to be paid on 60% of the income. So, if there is $10K of rental income on the property then $6K would be UDFI and would be subject to UBIT taxes.

For a more detailed outline on UDFI, please refer to my free one-hour webinar here.

Tip 3: UBIT Tax is Reported and Paid by the IRA via a Form 990-T Tax Return

Unrelated business income tax (UBIT) for an IRA is reported and paid via IRS Form 990-T. IRS Form 990-T is due for IRAs on April 15th of each year. IRA owner’s can file and obtain an automatic 6-month extension with the IRS by filing an extension request before the regular deadline.

If UBTI Tax is due, it is paid from the IRA and the IRA owner would send the prepared Form 990-T to their IRA custodian for their signature and for direction of payment to the IRS for any tax due as part of the 990-T Return.

For a more detailed outline of UBIT, please refer to Chapter 15 of The Self Directed IRA Handbook.

Nope - not my experience from my dealings with a tax attorney and the IRS! Income from rental attributed to the furnishings, which is obviously a big part of short-term rentals is taxable. If you rent out the property unfurnished and all that income stays in the LLC, and by extension, the IRA, then it’s not taxable when earned.

@ddmcghee

odd, i wonder what having it being furnished has to do with anyhing. I didn't see that anywhere.

@ddmcghee

you had to deal with the IRS??? You are scaring me now

yes - I had to file a 990-T each year to report the UBIT. I have a 2" binder full of correspondence, bank statements, rental receipts, and other documents for 3 years of taxes. My 2019 tax return was "open" with an ongoing issue until October of 2022. Two and a half years to get it all straightened out!

This is why I say it's a PITA and not worth it!

Also, if the property is used by yourself, friends, or family members who do not pay rent, then the entire investment amount can become taxable! When we stayed in our apartment, I always booked it through AirBnB, giving myself no better rate than the lowest nightly rate over the past 12 months.

When the IRS talks about real estate investment, they are not talking about short-term rental properties! 

You are not going to make a ton of rental income after all expenses, you can't (legally) use the property yourself without paying, and you are not going to have much appreciation on the property unless you hold it for a long time! The only way I would ever recommend anyone buying a property here to use as a rental is if you plan to use it yourself for a significant portion of the year and just want to rent it out to offset the costs when you aren't here. Even in that situation, if you choose to be here during the high season, you are going to have a harder time renting it and making top dollar over the summer and during hurricane season!

Boy nothing like sitting back in paradise and watching and enjoying your money working for yer……..😱

Boy nothing like sitting back in paradise and watching and enjoying your money working for yer……..😱
-@Tippj

I don't know of anyone making bank on rental properties here! I've had conversations with some who say they are "making" $1500 a month on their rental apartments. Start digging and find out that's only during high season, it's gross income and doesn't reflect expenses, property taxes, or income taxes. I sat down with one friend and did some back-of-the-napkin calculations. He was actually losing money!

And without looking closely they don't know!  Too few want to actually do the calculations! 

Income does not equal profit!

My two cents, I do know you can make a decent amount if you own commercial properties. Never like you would in say USA but maybe enough to live comfortable in DR

Hello! I am currently looking to set up an SDIRA for a pre-construction property that I will soon be closing on in Punta Cana. I am just learning about this process. Thank you for all the information.

Excuse my ignorance but any particular reason you chose to create an LLC/Checkbook LLC? @dougandkids and @ddmcghee I was under the impression that the Custodian could hold and transact on behalf of the property? ..I also saw in an older thread someone mentioning that DR does not recognize an IRA as a legal entity and cannot  hold property directly so this may be why?

The property will be used a ST Rental and I have the option to engage the property manager associated with the developer. I've familiarized myself with prohibited transactions and other IRS matters I should consider when purchasing RE with an SDIRA but feels like there is so much more to consider than US tax treatment and there isnt much out there for investments property in DR specifically.

Also anyone that has gone through the closing process through a SDIRA can provide more information on how it went and what to consider?

I am from the DR and have family in SD, but live and am a citizen in US. (If any of that is relevant, I still hold dual citizenship). I was planning to go be present for the closing, assuming this will not necessarily be considered a PT

Appreciate any input on this regard!

The SDIRA has to own an LLC with pretty specific Articles of Organization and Operating Agreement, stating the purpose of investing in and managing real estate. Once established, all transactions and management of the LLC fall to the Manager, who must be at arms-length from the IRA owner. That manager would need to be present for the closing, or complete a Dominican POA so that someone can represent them.

If you plan to use the property yourself, you must pay market rent and have proof of payment or risk having the entire investment deemed a withdrawal and subject to taxes and penalties.

Google John Hyre, the IRA Lawyer. He is both an attorney and tax accountant and specializes in self-directed IRAs.

Also, look long and hard at the returns you can realistically make with the property. Based on our experience, if we had put the investment in a nice, conservative index fund, it would have performed better!  And if your property is pre-construction, you will have a 0% return until it is completed, and completion will always take longer than any estimate you're given by the developer. Our home was built by a very experienced builder, and the construction took 50% longer than expected.