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Use Nonrecourse Leverage Tax-Free!

Unlike a Self Directed IRA LLC, when a Self Employed 401k Plan buys real estate that is leveraged with mortgage financing it is exempt from paying any Unrelated Business Taxable Income (UBTI) tax on the income or gain generated. Debt-financed property” refers to borrowing money to purchase the real estate or other property (i.e., a leveraged asset that is held to produce income, such as real estate or stock).

Section 514 of the Internal Revenue Code requires debt-financed income to be included in unrelated business taxable income. Section 514(c)(9) allows a few types of exempt organizations to make debt-financed investments in real property without becoming taxable under § 514. The provision applies to any “qualified organization,” a term that includes (1) schools, colleges, universities, and their “affiliated support organizations,” (2) qualified pension, profit sharing, and stock bonus trusts, such as a 401k Plan and (3) title holding companies exempt under § 501(c)(25). 5 Generally, indebtedness incurred by a qualified organization in acquiring or improving real property is not acquisition indebtedness if the transaction navigates through a long list of prohibitions. The price paid by the organization for the property or improvement must be fixed when the property is acquired or the improvement is completed, neither the amount nor the due date of any payment under the indebtedness can be contingent on the revenue, income, or profits from the property, and the property may not be leased to the person who sold the property to the organization or to any person related to the seller within the meaning of § 267(b) or § 707(b). If the organization is a 401k Plan, the property may not be purchased from or leased to the employer of any of the employees covered by the trust or any one of several persons related to the employer. 5Financing for the property may not be received from the person who sold the property to the organization, a person related to the seller within the meaning of § 267(b) or § 707(b), or, if the organization is a qualified employee trust, an employer or related person who is disqualified from being seller or lessee under the rule described in the preceding sentence. The property must usually be owned directly by the qualified organization, except that an interest in a partnership or other pass-through entity qualifies if all of the partners or other owners are qualified organizations and each partner or other owner is allocated the same distributive share of every item of partnership income, deduction, and credit.

With the UBTI tax rates at approximately 37%, the Self Employed 401(k) Plan offers real estate investors looking to use nonrecourse leverage in a transaction with a tax efficient solution. Using a Self Employed 401k instead of a Self Directed IRA LLC to purchase real estate will allow an investor to use nonrecourse leverage (a nonrecourse loan from a bank) to make a real estate purchase greatly enhancing the investor’s buying power as well as potential investment return.

To learn more about how the Self Employed 401k Plan structure nonrecourse-financing feature, please contact one of our 401(k) Experts at 800-IRA-0646 today!