When it comes to using retirement funds to make an investment, the Internal Revenue Code does not describe what a Self Directed IRA can invest in, only what it cannot invest in. Internal Revenue Code Sections 408 & 4975 prohibits Disqualified Persons from engaging in certain type of transactions. The purpose of these rules is to encourage the use of IRAs for accumulation of retirement savings and to prohibit those in control of IRAs from taking advantage of the tax benefits for their personal account. In general, there are four categories of prohibited transactions. The first is collectibles. A Self-Directed IRA LLC cannot Invest in life insurance contracts or collectibles defined below:
Any work of art
Any metal or gem
Any alcoholic beverage
Any rug or antique
The second is that a IRA funds cannot be used to purchase life insurance. The third is that a self-directed cannot purchase stock in an S Corporation as only individuals can be shareholders. The fourth, which is the broadest and comes into the play the most frequently, is that an individual may not enter into a transaction with a “disqualified person” that directly or indirectly benefits him/her. The definition of a “disqualified person” (Internal Revenue Code Section 4975(e)(2)) extends into a variety of related party scenarios, but generally includes the IRA holder, any ancestors or lineal descendants of the IRA holder, and entities in which the IRA holder holds a controlling equity or management interest.
With respect to a mobile park, as long as the IRA holder nor any disqualified will be actively involved in the operations of the park and the transaction does not involve any disqualified person or directly or indirectly involves a disqualified person the purchase of a mobile park is allowable using a Self-Directed IRA. However, there could be a tax that may be triggered by the income generated by the mobile park.
Pursuant to Internal revenue Code Section 512, a tax may be imposed on income generated by a charity or a retirement account from active trade or business income generated by a self-directed IRA or solo 401(k) Plan via a passthrough entity, such as an LLC or partnership. Note using a “C” corporation would block the application of the UBTI tax. However, Internal Revenue Code Section 512 does include several exemptions to the UBTI tax. The exemptions are generally passive category types of income, such as interest, dividends, capital gains, rental income, and royalties. However, when it comes to using a self-directed IRA to buy a mobile park investments the key question is whether the income generated by the mobile park investment would be considered rental income and, thus, exempt from UBTI tax.
Section 512(b)(3), enacted by the Revenue Act of 1950, modifies the definition of unrelated trade or business by excepting certain types of rents:
In the case of rents —
(A) Except as provided in subparagraph (B), there shall be excluded —
(i) all rents from real property (including property described in section 1245(a)(3)(C)), and
(ii) all rents from [certain] personal property.
Section 512(b)(3)(B) includes rent in UBTI (i) if more than 50% of the rent is attributable to personal property or (ii) if the amount of rent depends in whole or in part on the income or profits derived by any person from the property leased (other than an amount based on a fixed percentage or percentages of receipts or sales).
There is very sparse authority to flesh out the statutory provision providing for the rental exemption.5
Treas. Reg. § 1.512(b)-1 provides:
Whether a particular item of income falls within any of the modifications provided in section 512(b) shall be determined by all the facts and circumstances of each case. . . . [I]f a payment termed “rent” by the parties is in fact a return of profits by a person operating the property for the benefit of the tax-exempt organization or is a share of the profits retained by such organization as a partner or joint venturer, such payment is not within the modification for rents.
Treas. Reg. § 1.512(b)-1(c)(5)6 is the most important regulation in this area and provides
[P]ayments for the use or occupancy of rooms and other space where services are also rendered to the occupant, such as for the use or occupancy of rooms or other quarters in hotels, boarding houses, or apartment houses furnishing hotel services, or in tourist camps or tourist homes, motor courts or motels, or for the use or occupancy of space in parking lots, warehouses, or storage garages, does not constitute rent from real property. Generally, services are considered rendered to the occupant if they are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. The supplying of maid service, for example, constitutes such service; whereas the furnishing of heat and light, the cleaning of public entrances, exits, stairways and lobbies, the collection of trash, etc. are not considered as services rendered to the occupant. Payments for the use or occupancy of entire private residences or living quarters in duplex or multiple housing units, of offices in any office building, etc., are generally treated as rent from real property.
For more information on the rules surrounding the use of a self-directed IRA to make real estate investments, please contact a tax professional at 800-472-0646