This calculator is designed to illustrate the power of using leverage in an IRA, and compares the expected return on investment for an all cash purchase with the use of non-recourse mortgage financing. The mortgage calculations include the potential impact of UDFI taxation.
About this Calculator
This calculator is purely an educational tool designed to help investors compare making an all cash investment vs using a non-recourse IRA mortgage for the purchase of an investment property. Investors should not rely on the data provided for purposes of investment or tax guidance, and should consult with their tax and legal advisors prior to making decisions about the use of non-recourse financing in an IRA.
When an IRA borrows, the debt instrument must be non-recourse, meaning there is no personal guarantee from the account holder or other disqualified party to the IRA. Additionally, the use of debt-financing within an IRA creates exposure to Unrelated Debt Financed Income taxation (UDFI). The tax is levied on that portion of the IRA income that is directly attributable to the borrowed funds.
More information on non-recourse loans and UDFI taxation is available in our learning center.
While the use of non-recourse financing and the corresponding tax implications create added cost and complexity, the net result of using leverage in an IRA should be increased return on investment for your IRA capital.
UDFI Calculations
The Initial Basis value of the property includes the purchase price as well as closing costs and any rehab costs incurred prior to putting the property in service.
The basis of the property is reduced each year by the full amount of straight-line depreciation to produce the Adjusted Cost Basis for the year. The Adjusted Cost Basis represents the average of the cost basis on the first and last days within the year during which the property was held.
The Average Acquisition Indebtedness for a given year is the average outstanding principal amount on the mortgage for the portion of the year the property was held.
The Debt Financing Ratio for the year is then determined by dividing the Average Acquisition Indebtedness by the Adjusted Cost Basis.
Debt Financed Income is then calculated by multiplying the gross income of the property by the Debt Financing Ratio.
The Debt Financing Ratio is also applied to expenses such as depreciation, mortgage interest payments, and operating expenses like real estate taxes, insurance, repairs, etc. This produces the Allowable Deductions value.
The Allowable Dedications are then subtracted from the Debt Financed Income to produce the Net Taxable Income amount.
The first $1,000 of income is excluded per a standard exemption. The balance is then run through the trust tax table to produce the tax amount.
Notes
For purposes of simplicity, the calculator essentially assumes a property was purchased and put into service on January 1st and held for 5 full tax years. Adjustments for property held a partial year are not factored.
No consideration is made for increases of rents or cost of operations.
Significant rehab or upgrades occurring after a property was put into service and/or not foreseen at the time of purchase may impact depreciation and other factors of UDFI taxation on a property.
Only rental income is considered. Income generated from other sources such as laundry, parking, etc. would be factored into the UDFI taxation, and would have different calculations based on personal property depreciation, for example.
The UDFI Calculator- Leverage your IRA Goes here.
https://ira123.com/udfi-calculator-leverage-ira/
