Levering a rental inside an SDIRA can cost more in 990-T prep than in tax

Here is a case worth studying, because the loss sits in a line most people never model. Take a $215,000 three bed in a decent suburb bought inside a traditional SDIRA. $112,000 of IRA cash down, $103,000 non-recourse at 7.9 percent on a 25 year amortization with a 5 year balloon. The lender wants 48 percent down and six months of payments in reserve inside the account. Rent $1,875. The thesis is that leverage buys a better house in a better school district than $112,000 buys all cash, and the UDFI tax on the debt-financed portion will be a rounding error against the appreciation. The first half of that holds. The house is genuinely better than the $128,000 version the account would have bought otherwise. The second half is where it goes wrong, and in a direction most buyers do not expect. Year one: average acquisition indebtedness over average adjusted basis works out to about 47 percent. Net rental income after operating expenses, interest and depreciation is $4,180. So $1,965 of UDFI, less the $1,000 specific deduction, leaves $965 in trust brackets. Actual federal tax owed: about $190. The 990-T preparation runs $1,150. Year two it is $1,050. The state also wants a return, another $300 across the two years. So $2,500 of compliance spend against $410 of actual tax across two years, on an asset held in a tax-advantaged account whose whole point was to avoid tax. Add the loan costs: $4,300 in origination, appraisal and lender legal at close. And the rate is 7.9 against a comparable conventional closer to 6.4, which on $103,000 is roughly $1,500 a year of extra interest that a non-IRA buyer would not be paying. Run it all the way out and the levered version is ahead only if appreciation on the extra $87,000 of house clears about $6,000 a year, which is a bar many markets have not been clearing. What to do differently: run the compliance cost as a fixed annual line item before running the tax, because the tax was never the expensive part. And price the balloon. Refinancing a non-recourse IRA loan in year five is a real event with real costs, and a zero in that cell is a mistake.