I Want my IRA to Invest in “Green” Energy

Energy consumption is on the rise, both nationally and globally, and many new energy companies are popping up to fulfill the increased demand. Growth in the alternative energy industry has increased the number of wind turbines and solar panels that provide power to our homes. The oil and natural gas industry is also still booming, with technological advances in shale extraction leading to more opportunities for expansion. All this growth has caused many of our self-directed IRA holders to ask us how they can take advantage of this emerging industry as part of their retirement portfolio.

Whether the energy industry is something you have previous experience with or it is a new interest you have developed, the IRS allows SDIRA holders to pursue their interests and use their personal agenda or strategy when investing. Your IRA can invest in energy in a number of ways, including lending funds to an energy start-up through promissory notes, purchasing shares of private stock, or forming a limited partnership.

As the price of fossil fuels has increased, the popularity of renewable energy sources has soared. Wind and solar energy are becoming major players in the energy game, presenting investors with the opportunity to not only take advantage of an emerging industry, but also to invest in “green” energy sources. Those SDIRA holders who are concerned about making socially responsible investments can utilize these environmentally-friendly energy sources for their retirement portfolio.

Increases in the demand for energy are creating an emerging industry that could create an investment opportunity for self-directed IRA holders. As the account holder, it is important for you to perform thorough due diligence when choosing a new investment. Doing so will help you protect your retirement and allow you to find the right investment for you.

IRS Explains Unrelated Business Income Tax (UBIT) and Unrelated Debt Financed Income (UDFI)

At New Direction IRA, a self-directed IRA and HSA provider, we hear a lot of questions about UBIT, or Unrelated Business Income Tax.

Many investors are afraid of acting on money-making opportunities because they think UBIT is a penalty or an excessive tax. However, UBIT typically means that—in the case of retirement accounts—the account is making money. It is not a penalty, just a way to even the playing field between tax-exempt and tax-deferred entities like a retirement account and other entities/people.

To get a basic understanding of UBIT and Unrelated Business Taxable Income (UBTI) and Unrelated Debt-Financed Income (UDFI), that two types of income that may be assessed UBIT, let’s go straight to the source: the IRS. The IRS Publication 598 outlines what these tax consequences are and how you’ll incur them.

Below are some excerpts from the IRS that may help an IRA holder to understand the parameters.

Unrelated business income - Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function, except that the organization uses the profits derived from this activity.

Income - Generally, unrelated business income is taxable, but there are exclusions and special rules that must be considered when figuring the income.

Exclusions  - The following types of income (and deductions directly connected with the income) are generally excluded when figuring unrelated business taxable income.

• Dividends, interest, annuities and other investment income - All dividends, interest, annuities, payments with respect to securities loans, income from notional principal contracts, and other income from an exempt organization's ordinary and routine investments that the IRS determines are substantially similar to these types of income are excluded in computing unrelated business taxable income.
• Royalties - Royalties, including overriding royalties, are excluded in computing unrelated business taxable income.
• Rents - Rents from real property, including elevators and escalators, are excluded in computing unrelated business taxable income.
• Exception for rents based on net profit - The exclusion for rents does not apply if the amount of the rent depends on the income or profits derived by any person from the leased property, other than an amount based on a fixed percentage of the gross receipts or sales.

Gains and losses from disposition of property - Also excluded from unrelated business taxable income are gains or losses from the sale, exchange, or other disposition of property.

Unrelated Debt-Finance Income

Income From Debt-Financed Property

Investment income that would otherwise be excluded from an exempt organization's unrelated business taxable income (see Exclusions under Income earlier) must be included to the extent it is derived from debt-financed property. The amount of income included is proportionate to the debt on the property.

Debt-Financed Property

In general, the term “debt-financed property” means any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness at any time during the tax year (or during the 12-month period before the date of the property's disposal, if it was disposed of during the tax year). It includes rental real estate, tangible personal property, and corporate stock.

If you have any questions about UBIT, UBTI or UDFI, feel free to contact us at NDIRA by visiting www.ndira.com and giving us a call, email or chatting online with an IRA expert.

(Information provided by the IRS publication 598.)

What is a Self-Directed IRA? What are Alternative Assets?

The term Alternative IRA, which has been in the news so much recently, is frequently misunderstood. It is often thought to be an IRS designation that signifies an account type that is different from a traditional IRA or a Roth IRA, which are designated IRS account types. It is also not unusual for people to be under the impression that self directed means that the IRA owns an LLC which holds the IRA assets. Neither of these is the case.

“Alternative” as well as “Self Directed” are descriptive terms, not legal distinctions, and are used largely as marketing tools. ( In fact, terms such as “Rollover IRA”, “Real Estate IRA”, and “Gold IRA” are also descriptive and used primarily for marketing.) The only consistent meaning that alternative IRA might have is that the assets held by the account include something other than stocks, bonds, mutual funds, etc. And the
meaning of self directed IRA is basically that the IRA holder will have some choice in terms of what assets the account will hold. That may be a choice between two or three publicly traded stocks or bonds or funds, or it may be the ability to choose real estate, gold, private lending, investment in private companies, and more. IRA providers are not bound by the IRS to offer any particular suite of assets. It is incumbent upon the IRA holder to choose a provider that services the desired asset types.

The IRS, which governs IRAs, allows two basic tax arrangements for retirement accounts:

1) With a Traditional IRA, the IRA holder contributes money to the account “pre-tax”. While that money is in the account, it performs tax-deferred, meaning that the increase or decrease in its value does not have an effect on the IRA holder’s personal annual taxes. The only time that the IRA holder’s personal taxes are affected are when they make a contribution or take a distribution. A contribution will decrease the amount of earned income that the account holder declares for a tax year. And when a distribution is taken, the amount of the distribution is then added to the person’s annual income for that tax year and taxed accordingly.

2) In a Roth IRA, contributions by the IRA holder are “post-tax”; the investments in the account perform without tax consequence; and then can be distributed tax free to the IRA holder after the age of 59.5. These two basic arrangements, along with the associated rules for contributions and distributions, are the same for all IRAs, alternative or not, self-directed or not. For example, if a person opens a traditional IRA that is self-directed with a provider like New Direction IRA, which handles a wide array of alternative asset types, that account holder could have that IRA invested in a couple of rental houses and some gold bars. The rental income and appreciation of the real estate and the appreciation of the gold would constitute the performance of the assets. Regardless of what the assets were, the IRA holder could continue to make contributions per IRS regulations.

With any IRA, there are two dynamics occurring that affect the account’s balance. The first is the pattern of contributions and distributions. These are governed by IRS rules and the IRA holder’s strategy. The second is the performance of the money/assets that are in the IRA. This is governed by the economic factors associated with each particular asset. In other words, was it a profitable investment or not. The two dynamics are only related in that they are functions of the same account and are guided by the IRA holder. These dynamics are not affected by whether an IRA is self directed or not and whether the assets are publicly traded securities or alternative.

In the case of IRA terminology, it may be that marketing attempts to make the consumers’ options more understandable have back-fired and actually created less understanding. It can be helpful to remember 3 categories of terms:

1) IRS designations are account types (Traditional, Roth, or an employer plan). These account types have rules associated with them about taxation and contributions/distributions.

2) Asset terms are simply that, the type of asset in which the IRA is invested: real estate, gold, loans, stock (public or private), etc.

3) Descriptive terms are used to help lead the consumer to the service that they desire (i.e. an IRA that has gold or real estate or an IRA that results from a 401(k) rollover) and do not affect tax status.

All of the current conversation regarding “Alternative” and “Self Directed” IRAs, may seem confusing unless one is familiar with the terminology. Whether it is the success of Mitt Romney’s IRA or the Jean Chatzky report on the Today Show that is fueling interest in retirement investing, what is certain is that IRA account holders are becoming more and more aware of the choices that they have when it comes to their retirement funds.