Real Estate and UDFI Tax

Real Estate and UDFI Tax

Unrelated Debt-Financed Income (UDFI) Tax: What Real Estate Investors Need to Know

WHAT IS UNRELATED DEBT-FINANCED INCOME TAX (UDFI)?

Unrelated Debt-Financed Income Tax (UDFI) is a tax that applies to gains from an asset received by an IRA. UDFI is derived from debt financing used to obtain the asset. You might be thinking, “Doesn’t my IRA, a tax-advantaged account, prevent me from being taxed on my investments?” and you would generally be right if your IRA does not participate in any taxable activities. However, a few actions can cause a tax-advantaged account or entity to be taxed on its gains. Today we will concentrate on self-directed real estate investments that can be taxed.

As the name implies, Unrelated Debt-Financed Income Tax is a tax for tax-advantaged accounts or entities. Income attributable to gains obtained through debt financing is susceptible to UDFI. If you use debt to acquire an asset within a tax-advantaged account (such as a self-directed IRA), you have to pay UDFI on a portion of your net income from that asset. If you use a non-recourse loan to fund your IRA’s real estate purchase, you pay UDFI on that property’s gains. Learn more about non-recourse loans in a tax-advantaged account.

HOW IS UDFI CALCULATED?

Now that we know what UDFI is, we will learn how to calculate your estimated payment. We will also learn how to report it on your 990-T. You need to know three main figures. As mentioned before, UDFI is a tax that is applied when debt financing assists in you obtaining income. The ratio of equity to debt used to purchase the investment is the first key figure you need to know. In our example, let’s assume you buy a property worth $100,000 with $40,000 of financing in your self-directed IRA. In this example, 40% of the property is debt-financed. Consequently, 40% of all income from that property is directly attributable to that debt financing.

Next, we need to know your property’s net income attributable to the debt. We also need to know the UDFI tax rate you fall into that year. As a reminder, net income is your gross income minus your asset’s expenses and any applicable deductions. For our example, let’s say the total net income is $5,000. So, net income attributable to debt is $2,000 ($5,000 total net income x 40% debt to value ratio). You then apply any reductions in UDFI for which your retirement account may be eligible. Next, apply the appropriate UDFI tax rate to that figure. That will be the amount you will report on your 990-T when you file your taxes. That amount is your UDFI tax burden that year.

CAN I AVOID PAYING UDFI?

As mentioned before, UDFI tax rates can reach as high as 37% in one year. UDFI is something that deserves serious consideration for investors thinking about using leverage in their self-directed retirement accounts. Thankfully, options are available for certain investors to avoid paying UDFI altogether.

Internal Revenue Code Section 514(c)(9) outlines that Individual 401(k) (or Solo 401(k)) plans are exempt from paying UDFI. This exemption makes a self-directed 401(k) a powerful tool for investors looking to use leverage to purchase their investments. However, something worth mentioning is that not everyone is eligible to have an Individual 401(k). There are specific qualifications that need to be met to have an Individual 401(k). Learn more about Individual 401(k) plans and their qualifications.

Another method to avoid paying UDFI is to restructure your investment to exclude the use of receiving debt financing. You may consider loaning funds from your IRA to a non-disqualified party to purchase the property themselves. They can then issue principle and interest payments to your IRA to repay the loan. This method provides an indirect way to participate in the property’s future gains. The borrower repays your IRA, but you do not use debt to access these gains.

Several other strategies can reduce or eliminate your self-directed retirement plan’s UDFI tax burden. Ultimately, your individual circumstances will determine the method you choose. We recommend speaking with a CPA or financial advisor to discuss the strategy that works best for you.

If you are looking for information on self-directed IRAs or an Individual 401(k), www.midlandtrust.com is an excellent resource to start. Or, call us at (239) 333-1032. We would be happy to discuss our services with you and how you could incorporate self-directed IRAs or an Individual 401(k) into your investment portfolio.

MIDLAND TRUST IS NOT A FIDUCIARY: Midland’s role as the custodian of self-directed retirement accounts is non-discretionary and administrative in nature. The account holder or authorized representative must direct all investment transactions and choose the account’s investment(s). Midland has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.

Dealing With Student Loans

Dealing With Student Loans

We hear it over and over that student loans are at all-time highs. Student loans prohibit Millennials from getting ahead financially and prevent many from buying a house, saving for retirement, or even having emergency funds for life’s unexpected expenses. With this said, let’s take a look at some statistics to understand how concerning the problem is.

As of December 31, 2019, the average federal student loan debt was $35,397, and the total student loan debt has reached $1.64 trillion. Not only that, but it is not uncommon to have student loans upwards of $100,000 from prestigious universities or due to advanced degrees. With this in mind, let’s talk about student loans and how you can keep them at manageable levels, so it does not negatively affect your future.

Mindful Spending

If you are currently in college or are considering going back to school for an advanced degree, here are a few ideas on how to lower your costs of tuition:

  • Consider starting your first two years at a community college. These schools are often inexpensive compared to more prominent universities. Community college can be an excellent way to save money until you are ready to transfer to the university of your choice.
  • Utilize scholarships and grants. Once you are accepted, consider applying to as many scholarships and grants for which you qualify. These financial aid options can be a great way to make college more affordable.
  • Search for books and supplies using alternatives to your school’s bookstore. Consider searching for textbooks online or find a textbook rental option near your school. Often, you can find them used and much cheaper than what the university charges.
  • Only take out what you need in student loans to avoid more debt than is necessary.
  • Consider making payments towards the loans to save interest while you are still in school. Whether through a job or an internship, paying as much as possible towards your student loans can make a significant impact.

Create a Payment Plan

Creating a payment plan is a great way to get started on the journey of paying off student loans as fast as possible. Here are a few ideas to create an effective payment plan:

  • The first thing to do is evaluate all of your loans and review your payment options. Learn about and understand your interest rate, minimum monthly payment, and payment plan.
  • Next, write down your goals on when you would like to have your loans fully paid off. Consider using SMART goals, which are: Specific, Measurable, Attainable, Relevant, and Time-Bound. By utilizing these parameters, paying off student loans can be worked into your budget easily. Then, write out your monthly budget and work your payments into it.
  • There are also options you can use to discount your student loan interest, such as setting up automatic payments through your debit account. Find out which options are available to you.
  • Once you set your goals and budget, the next step is to stick to it and reevaluate it every month. Reviewing where your money went will allow you to see where things went well and which areas need work.
  • Apply additional income towards your student loans to pay them off even faster. You could achieve this by getting a raise at work or a part-time job.

Utilizing these methods will ensure that you are mindful while you are in college and stick to a payment plan and budget once you graduate. Student loans do not need to be a massive burden on your life, and by being proactive, it can make a big difference in the long run.

Budgeting Tools That Millennials Love

Use an app such as Mint, Simplifi, or Dave Ramsey’s Every Dollar. These apps can consolidate your accounts and break down your expenses into categories, making things easier to view. They can also send you alerts when your balance is low, or you have upcoming bills. We have found www.studentloanplanner.com to be an excellent resource for managing student debt.

Eliminating student debts allows for more freedom to save and invest for retirement. If you are looking for information on self-directed IRAs, www.midlandtrust.com is an excellent resource to start. Or, call us at (239) 333-1032. We would be happy to discuss our services with you and how you could incorporate self-directed IRAs into your investment portfolio.

MIDLAND TRUST IS NOT A FIDUCIARY: Midland’s role as the custodian of self-directed retirement accounts is non-discretionary and administrative in nature. The account holder or authorized representative must direct all investment transactions and choose the account’s investment(s). Midland has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.

Credit Card Debt Management Tips

Credit Card Debt Management Tips

Many of us did not learn how to budget in college or from our parents. This vital life lesson is a rude awakening, and some Millennials may never fully be able to do it without professional help. It involves discipline and, for some, the retraining of your brain, a proper attitude towards money, and good habits. We are shaped by our upbringing. Our parents most likely play the most prominent role in how we treat money throughout our lives. These lessons can be learned directly by parents helping to manage money, or indirectly by seeing how your parents handle money firsthand while growing up. To change, you need to recognize and acknowledge where you currently stand and where you want to be. Take a moment to truly reflect on this before continuing. Once you’re ready, read on to learn about credit card debt management tips.

LEARNING ABOUT CREDIT CARDS AS A YOUNG ADULT

I owned a credit card in high school. The credit card was strictly for gas and food, and my dad watched the card like a hawk. If I ever purchased outside of those two approved needs, I had to pay using my cash savings. I earned my cash savings from mowing lawns, shoveling snow, and birthdays. My father always paid the credit card on time, leading to me building a credit score for myself. At the time, I did not care or realize the significance of a credit score.

On the flip side, I have an uncle who racked up credit card debt. It was always mind-boggling to me knowing he had credit card debt, yet he never seemed eager to pay it off on time. My uncle’s flawed approach lasted for years and continues today. He doesn’t seem to mind or care as he always wants the newest and best technology, splurging on gifts for himself or others. My parents would talk about his reckless habits with me, and I am glad they did. I was able to learn and understand the importance of managing debt.

Seeing how my parents and uncle treated credit cards, I concluded that I never wanted to be in credit card debt. Having the latest and greatest gadget and spending money I could not afford was not the route I wanted to take. The amount of interest being paid on my uncle’s credit and his continuous use of the card kept him in credit card debt. By being in debt, you pay someone else hundreds to thousands of dollars over time to buy something you cannot afford. This money you pay in interest is money you could spend on yourself or savings/retirement. This strategy could shed years off how long you have to work to retire comfortably. Whether he likes it or not, the best thing for my uncle is to shred the credit card and create a monthly budget around eliminating the credit card debt.

USING CREDIT CARDS TODAY

In college, I had income from a summer job. My father passed the responsibility of making credit card payments to me, but still had full access to view my spending habits. You would think I would use the credit card for everything, but this was in 2008 before digital payments took off. I only used the credit card for paying for gas at the pump because it was convenient. Otherwise, cash was king for me. When I ran out of funds at the end of my freshman year, I said goodbye to splurging on entertainment and snacks.

Fast forward nearly a decade later, and smartphones, online banking, and digital payments are the new way of life. People can now make credit card payments using Venmo, PayPal, and Apple Pay. When I was young, my father only used his credit card for gas and occasionally to pay for meals at restaurants. My father now uses his credit card for nearly everything! However, unlike my uncle, he never spends more than he can afford.

Credit cards also offer great perks with money-back incentives for use on every purchase. Using my credit card for everyday purchases, I gather hundreds of dollars in cash back rewards each year. Like my father, I use my credit card as if it were a debit card. I pay the balance off nearly every day from my banking application. Making daily payments allows me to view my cash balance, which is my budget for the month.

PROS & CONS OF USING A CREDIT CARD

Pros of Using a Credit Card

  • Cashback rewards
  • No need to carry cash (stolen cash is easier for a thief to get away with opposed to a credit card or smartphone, which may not even be accessible)
  • Temporary emergency-use for essentials, if needed
  • Can help you build your credit score if used properly

Cons of Using a Credit Card

  • Very high-interest payments if not paid on time
  • If not disciplined with money, it can easily lead to you spending money you do not have, leading to credit card debt
  • Need to be on high alert for credit card fraud
  • Can ruin your credit score if not appropriately treated and payments are not made on time

4 Tips For Handling Your Credit Card

I am by no means an expert on credit cards, but I can assure you that I have never taken on credit card debt, nor do I plan to. The interest charged is astronomical, and I never want to put myself in that position. Here are some tips for managing your credit card:

1. TREAT YOUR CREDIT CARD AS A DEBIT/CHECKING ACCOUNT

Only spend what you have in your bank account, and no more. This approach also means setting and knowing your budget.

2. KNOW YOUR ESSENTIAL COSTS

Know your essential costs for the month and put this into a separate account. As earnings come into your bank account, know what your essential costs are. Essential costs can include loans, insurance, rent, or mortgage. These costs can also include transportation, utilities, real estate tax (if you own a home), and more. Calculate what these costs come out to monthly. Set this amount aside each month into a separate account. Do not use this set-aside money.

3. PAY OFF YOUR CREDIT CARD REGULARLY

I log onto my bank account every morning and pay off my credit card balance every day. Doing this allows me to see my bank account’s cash balance and gives me an idea of how much money I have remaining. I use the remaining funds for food, fun, and entertainment. With daily credit checks, I am constantly aware of my cash balance and dramatically lower my risk of fraud. I would potentially catch any sign of fraud instantly and begin working with my bank to freeze the card or issue a new one.

4. FOR EMERGENCIES, DEVELOP A PAYMENT PLAN OR “MONEY-CRUNCH”

If you need a credit card for an emergency, try to either work on a payment plan or go into a “money-crunch” mode. If there is an outstanding balance on your credit card that will take a while to pay off, you should also go into a “money-crunch” mode. Stop eating out, find free entertainment options, or temporarily reduce your 401(k) contribution. Try to crunch your budget until you’re back in the black or green. Reduce and avoid credit card debt at all costs. I view any interest paid on my credit card as money thrown away or burned.

6 Tips For Managing Your Credit Card Debt

Being free of credit card debt means the freedom to do more with your hard-earned money. Credit cards are not for everyone, and that is okay. If you find yourself unable to get your head above water with credit card debt, you may need to stop using your credit card altogether. Adding to existing credit card debt with an astronomical interest rate will make it more challenging to get out of that debt. Credit cards charge a very high interest when not paid off on time, between 15% to 29%! Here are some tips for managing your credit card debt:

1. SHRED THE CREDIT CARD

Click here to learn about the safe way to cancel a credit card.

2. PAY MORE THAN THE MINIMUM

Option 1: Snowball Effect

Pay the minimum balance on all credit cards/debts and eliminate the smallest credit card balance first. Psychologically, this reduces the number of credit cards you have to worry about and allows for progress to be easily seen!

Option 2: Avalanche Effect

The other option is to pay the minimum balance on all credit cards. Find out which credit cards have the highest interest rates and pay those off first. While you will not receive the satisfaction of eliminating one of the credit cards in its entirety quickly, it will save you the most money in the end.

3. CREATE A BUDGET

Begin creating a monthly budget and list your credit card payments (more than the minimum) as one of the essentials you need to pay off every month.

4. USE CASH

Using cash in your wallet will keep you more honest with your budget. If you don’t have cash for the purchase, it is time to go into starvation mode and either cut costs or find a side hustle.

5. LIVE BELOW YOUR MEANS

Live below your means until the credit card debt is eliminated. This means no eating out and no unnecessary purchases. Reduce credit card debt at all costs. I cannot stress this enough. Money paid in interest on a credit card is money burned, thrown away, and gone forever.

6. FIND A PARTNER TO KEEP YOU ON TRACK

In the early days, my father kept me on track. Have someone assist as a coach or mentor. A coach or mentor can provide many benefits. You may not want to let them down. They can also be someone you celebrate with when you reach a set goal or milestone in eliminating your credit card debt.

Credit cards can provide great perks and rewards; however, they need to be used very carefully! Credit cards are not for everyone and, at most, should be a last resort. Learning to manage money better and setting a budget for yourself is one of the best things you can teach yourself. No excuses. You are never too old to learn and try something new. Motivate yourself to take action now and secure your financial well-being.

If you have any questions regarding your investment options in regards to saving and building wealth for your future, please contact Midland Trust at (239) 333-1032 or visit www.midlandtrust.com. We would be happy to discuss our services with you and how you could incorporate self-directed IRAs into your investment portfolio.

Author: Andy Anger, Client Services Senior Associate at Midland IRA, Inc.

MIDLAND TRUST IS NOT A FIDUCIARY: Midland’s role as the custodian of self-directed retirement accounts is non-discretionary and administrative in nature. The account holder or authorized representative must direct all investment transactions and choose the account’s investment(s). Midland has no responsibility or involvement in selecting or evaluating any investment. Nothing contained herein shall be construed as investment, legal, tax, or financial advice or as a guarantee, endorsement, or certification of any investments.