Filing taxes can be confusing because the tax code tries to address many different possibilities. This is especially true for a Real Estate IRA. There are many different types of Real Estate IRAs and different ways for account holders to interact with them. Here is a breakdown of some of the most common scenarios and the filings that are required. If you have any questions, ask your accountant or drop us a line.
Custodian Filing For a Real Estate IRA
Every kind of Real Estate IRA (e.g. Custodial, IRA LLC, etc,.) requires a Custodian to hold the account. One of the official duties of the Custodian is to file IRS Form 5498. This form details activity in your IRA including any contributions you may have made, rollovers, and Required Minimum Distributions (RMDs). This form is required to be filed by June 1 every year. The good news is that the Real Estate IRA account owner doesn’t have to do anything. The Custodian will file this form on your behalf and will send you a copy for your records.
Federal Tax Filing For a Real Estate IRA LLC
In most cases, the LLC is a single-member LLC and is therefore a disregarded entity for tax purposes. This is because of its status as a “pass-through” entity. All profits pass through the LLC and straight to the owner. In this case, the owner will be the IRA and any LLC income will be considered as regular IRA income. As such, the LLC would not need to file an annual tax return.
If the Real Estate IRA LLC is formed as a partnership, more tax documentation is necessary. For the most part, the partnership will still be considered “pass-through” with each of the partners responsible for paying their respective taxes. However there are informational forms which need to be filed. These include:
- Schedule K-1 – This is an IRS tax form which is filled out annually for each member of a partnership. It reports each partner’s credits, deductions, earnings, and losses. Schedule K1 is filled out as part of Form 1065. When the member is an IRA, the K-1 is issued to the Custodian.
- Broad uses Madison Trust as its Custodian and you would fill out the K-1 as “Madison Trust Company FBO [Account Holder’s Name]” and shows Madison Trust’s EIN.
- Form 1065 – This is the official partnership tax return.
UBTI In a Real Estate IRA
Most income from a Real Estate IRA is considered passive income and thus not subject to any tax liability. This would include rental income and proceeds from the sale of a property. However, there are a few situations where a Real Estate IRA would have to pay taxes. One of these is UBTI – Unrelated Business Taxable Income. This occurs when real estate takes on the form of an active business rather than a passive investment property. One example is a Real Estate IRA that engages in a series of property flips. Although the exact number is somewhat hard to define, it is generally understood that holding a property for a year or longer removes any UBTI liability.
If your Real Estate IRA is subject to UBTI, you will have to fill out Form 990-T. In this case the tax is owed by the IRA itself (because the LLC is “pass-through”,) and the funds paying the tax must be IRA funds. Form 990-T must be filed by the tax deadline, separate from your personal tax return. If you expect the tax for the year to be at least $500, you are required to pay a quarterly estimated tax.
UDFI In a Real Estate IRA
Another case where a Real Estate IRA may have tax liability is UDFI – Unrelated Debt Financed Income. If you use a non-recourse loan to invest in a property, then the percentage of the property which was financed by the loan incurs tax liability. For example, if you bought a $100,000 property with your Real Estate IRA and took out a loan of $20,000 to make it happen, then 20% of incoming profits will be taxable. UDFI is filed with form 990-T.
State Tax Filing For a Real Estate IRA LLC
Rules vary from state to state, as do the names for the taxes or fees that must be paid. Most states just go with the Federal approach which is not to consider the LLC independently. The LLC owner would pay any relevant taxes solely on their personal returns. However, there are some exceptions. Some states charge LLCs an income based tax, while others charge a flat annual tax or fee. Ask your accountant about the filing requirements for your specific state.
Capital Gains Tax In a Real Estate IRA
There are no capital gains taxes in an IRA or in its assets.
Tax Filing For a RMD
When a Real Estate IRA account holder reaches 72 years of age, they must start taking RMDs. These distributions are considered as taxable income. The RMD will be noted on Form 5498 that is filed by the Custodian. The tax filing itself will take place on your regular tax return (Form 1040).
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