Fund says IRA investors should expect UBTI on the K-1, trying to size the haircut

Question

I'm reading the PPM for a value-add multifamily fund. Target leverage 65 percent at the property level, and there's a paragraph telling tax-exempt investors to expect unrelated business taxable income reported on the K-1. My IRA would commit 100k.

My rough model: if the fund distributes 8 percent, that's 8k, 65 percent of it is debt-financed, so about 5.2k of UBTI. Take off the 1,000 deduction and I'm taxing 4.2k at trust rates, call it 1.3k. So roughly a 16 percent haircut on the income, and presumably something similar on the gain when they sell in year five.

Two things I can't work out from the documents. Is that percentage really the right one to apply, and who physically writes the check to the IRS, me or the custodian? The subscription agreement is silent on both.

Rena Expert · Accepted Answer

Your 16 percent is modeled off the cash distribution. UBTI keys off the taxable income allocated to you on the K-1, which in a depreciating value-add fund can sit near zero or go negative for the first few years even while the fund distributes 8 percent. Depreciation and interest expense allocable to the debt-financed portion come off before you get to UBTI, and losses carry forward against future UBTI inside that same IRA. So the early years may cost you nothing and the sale year may cost you a lot.

The fraction isn't the 65 percent headline either. It's average acquisition indebtedness for the year over average adjusted basis of the property, which drifts as principal amortizes and as basis changes. On a disposition, the debt-financed percentage uses the highest acquisition indebtedness during the 12 months before the sale, so a fund that pays debt down or off well ahead of closing changes the answer.

The IRA is the taxpayer. It gets its own EIN, files Form 990-T, and pays from IRA cash. Paying that tax with money from your checking account is a contribution, and if you're over the limit or past 70 it creates a different problem. So the IRA needs uncommitted cash in the sale year. Custodians either prepare the 990-T for a fee (300 to 1,200 is the range you'll see on published schedules) or hand it to you and expect a CPA return. Roth doesn't help here, UBIT applies to Roth IRAs the same way.

The practical failure I'd plan for is K-1 timing. Sponsor K-1s often land after the filing deadline, so you'll be extending most years, and the custodian needs a signed authorization to file the extension. Have a CPA who has actually filed 990-Ts price this before you subscribe.

marcus_hale41 · Answer

Ask the sponsor for a redacted prior-year K-1 for an IRA investor, specifically box 20 code V. Some will send it, and the ones who won't tell you something too. Also worth asking whether they offer a blocker corporation feeder for tax-exempt investors. A blocker pays entity-level corporate tax and the IRA receives dividends, so you trade one rate for another, and it only makes sense if the UBTI is large enough to hit the top trust bracket. Most sponsors under about 50m of equity don't bother offering one.

derekj19 · Answer

Does the fund administrator charge the IRA separately for the tax package, or is that inside the management fee? I've seen admin fee schedules that bill per investor per K-1 and I couldn't tell whether that gets netted against distributions or invoiced to the custodian.

raj_mehta14 · Answer

So if I bought the debt side of that same deal instead, a mezz piece or a participation in the senior loan, the interest comes back to the IRA with no UBIT at all? That's what I've pieced together, that interest is exempt as long as my IRA isn't the one that borrowed. If that's right, the equity structure is the only reason there's a tax bill here.

stephen_ok9 · Answer

@vellum that's the shape of it, and it's why so much retirement money ends up in debt funds rather than equity funds. The trade is that you cap your upside at the coupon. Compass is buying the appreciation, which is the piece that gets taxed hardest inside the wrapper because of the sale-year debt-financed gain.

dmitri_v6 · Answer

Check the subscription agreement for a clause saying the fund makes no representation about UBTI and will not provide estimates. It's standard and it means you're guessing until the K-1 shows up. I'd also look at whether the LP agreement lets the manager suspend distributions, because if it does, you can get a UBTI allocation in a year with no cash coming in. The IRA still owes. That's the mismatch that catches people.

priya_n21 · Answer

So the 8 percent isn't 8 percent, and you don't know what it is until March or later. Noted.

wendy_park48 · Answer

One more from the paperwork side. The net operating loss carryforward sits with that specific IRA, not with you. If you split the position across two IRAs, or roll assets between custodians mid-stream, the loss history has to travel with the right account and the new custodian will not reconstruct it for you. Keep every 990-T you ever file in your own records, because custodians change platforms and the older filings tend to disappear from the portal.

Fund says IRA investors should expect UBTI on the K-1, trying to size the haircut

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