UDFI and UBIT Tax Examples

UDFI and UBIT Tax Examples

Example 1:

Husband and Wife caused their IRAs to make self-directed investments into an LLC that purchased a rental home.  Each IRA is a 50% member of the LLC.  The property needs repairs that will cost more money than the LLC has available.  Can Husband and Wife cause their IRAs to make additional capital contributions to the LLC to fund the repairs?

Answer:  No.  If either IRA were to make an additional capital contribution to the LLC, it would create a prohibited transaction under Internal Revenue Code Section 4975(c), which provides that a:
“prohibited transaction” means any direct or indirect— . . . transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan”
Because the two IRAs each own 50% of the LLC, the LLC is a disqualified person under Section 4975(e)(2)(G).  This provision says that a disqualified person is an entity 50% or more of which is owned by a fiduciary.  Each IRA custodian is a fiduciary with respect to its IRA account and because the custodian owns 50% of the LLC, the LLC is a disqualified person.  Therefore a transfer of money from the custodian to the disqualified person (the LLC) to fund the repairs is a prohibited transaction.​

Example 2:
Same Scenario as above. BUT, others take the position that since the only benefit the IRA holders’ would experience as a result of the additional investment into the new entity would be a benefit they would be entitled to as beneficiary of the IRA, which is exempted from the prohibited transaction rules pursuant to Code Section 4975(d)(9), the additional IRA investment into a newly established entity would not trigger a prohibited transaction. HOWEVER, I must caution you to note that this position has mainly been applied only where there is only one IRA account that owns 100% of the IRA LLC, not when it is 50/50 owned along with the other IRA Account. 
Ultimately the decision is yours when it comes to this situation, but please understand that there is not much guidance on this issue and the IRS may consider it to be a prohibited transaction.