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All Cash vs Leveraged Property in an IRA

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.

Property & Purchase

  • Property Description: Enter Property Description (i.e. Single-Family Residence, Duplex, Vacation Rental, etc.)

  • Property Type: The type of property determines the depreciation schedule. Residential property is depreciated over a 27.5 year span, while commercial property is depreciated over 39 years.

  • Purchase Price: the contract price of the property, excluding fees and commissions.

  • Land Value: The value of the raw land on which the property is located. This value can generally be found in public tax records for a property. The land value is not part of depreciation calculations.

  • Building Value: The value of developed structures on the property. For purposes of this calculator, the building value should reflect the cost value of the purchase (less land value) plus any immediate rehab costs incurred prior to placing the property in service.

  • Non Lender Closing Costs: Include typical closing costs such as title insurance, sales commissions and inspections. Do not include lender costs here.

  • Rehab Costs: Repairs and upgrades that were planned and/or reasonably foreseeable at the time of purchase can be included in determining the cost basis of the property for purposes of UDFI calculation. Generally speaking, this should only include costs incurred prior to placing the property in service. This calculator does not address the more complicated scenarios that would arise with subsequent improvements which would require an independent depreciation schedule.

  • Property Description: Fair Market Value of property when placed into service (after purchase/rehab).

  • Expected Appreciation: Average annual property appreciation

Financing

  • Cash Down Payment: Down payment made with IRA funds.

  • Loan Amount: Amount borrowed for purchase/rehab.

  • Interest Rate: The most common commercially available non-recourse mortgages for an IRA or 401(k) will be in the 4.25% to 6.25% range. Private financing such as seller carry-back, or hard money may have higher rates.

  • Lender Costs: Lender fees or mortgage points. This calculator assumes points are paid up front and not amortized into the loan. Common commercial lender expenses are 1% of the loan amount (1 point) + $600-800 in processing and underwriting fees.

  • Term in Months: Enter the amortization period of the loan in months. i.e. 5 years = 60 months, 20 years = 240 months.

Income

  • Monthly Rent: The gross rental amount for the property. Sum all rents for multi-unit properties. For purposes of simplicity, no allowance is made for rent increases (or corresponding expense increases).

  • Vacancy Rate: The percentage of time per year a property is vacant. Rate varies widely by location, neighborhood within various cities, and over time. The national average for residential properties in 2015 is 7.53% and trending slightly downwards.

Annual Expense

  • Property Taxes: Be sure to confirm what your expected tax rate will be. Often times, the rate can increase from what a prior owner was paying.

  • Property Management: Property management services and costs can vary widely. A common formula used by property managers is one half to one month’s rent to place a tenant and 6-8% of monthly rents. Some managers include advertising and tenant screening in their placement fee while some do not. If a property rents for $1000/month and you work with a manager who has an average tenant retention rate of 3 years, charges ½ of a month’s rent to place a tenant, and 7% monthly, then you would average your annual management expense to be $1006 per year (($36,000*.07)+$500)/3).

  • Insurance: Enter the annual insurance cost. In addition to a casualty/landlord policy, you may wish to obtain a blanket liability policy for your IRA or 401(k).

  • Repairs and Maintenance: This value should represent the expense of all basic maintenance and repair activity for your property, including categories such as lawn care or snow removal. The age and type of property will certainly have an impact on what you can expect in this category. 1% of the property value per year is a good benchmark for a newer property in good condition initially. If the property is part of a HOA, this value may be lower as certain exterior expenses would be covered by the HOA.

  • Utilities: Utilities not paid by tenants

  • HOA: Homeowner Association Fees

  • Other Expenses: If you expect to have other expenses not covered above, enter the annual total here.

  • UDFI Tax Preparation: Enter the cost of bookkeeping and 990-T preparation for UDFI tax assessed when an IRA receives income from a leveraged property investment. Your expense will vary based on the complexity and number of properties, but would typically be in the $350 - $600 range for most investors.

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    IRA Property Investment Analysis: All Cash vs Mortgaged

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  • Property & Purchase Info

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  • Financing Information

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  • Gross Operating Income

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  • Annual Operating Expenses

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    IRA Property Investment Analysis: All Cash vs Mortgaged

    
  • Year 1 Cash Flow

    •   All Cash Purchase Mortgaged Purchase
      Gross Operating Income
      Annual Operating Expense
      Net Operating Income
      Annual Debt Service
      Cost UDFI Taxation
      Cost of UDFI Tax Preparation
      Annual Cash Flow
      Annual Cap Rate
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  • 5 Year Return on Investment Analysis

    •   All Cash Purchase Mortgaged Purchase
      Initial Cash Investment
      Initial Property Value
      Property Value with Appreciation
      Equity Increase
      Cash Flow Received
      Total Return
      Return on Investment with Appreciation
  • 5 Year Return on Investment Percentages

    •   Initial Cash Investment Equity Increase Cash Flow Received ROI w/ Appreciation
      All Cash
      Mortgage
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  • Relative Performance of All Cash vs Leveraged Investment over Five Years

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    IRA Property Investment Analysis: All Cash vs Mortgaged

    
  • Loan Balance & Equity

    • Year Total Payments Principal Paid Interest Paid Ending Principal Balance Property Value Equity
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  • UDFI Illustration

    • $1000
    • Year Avg
      Acquisition Debt
      Adj
      Cost Basis
      Debt
      Financing Ratio
      Debt
      Financed Income
      Allowable
      Deductions
      Net
      Taxable Income
      Tax Amount
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  • Information provided by this calculator is made available to you as a self-help tool, and is not intended to provide tax or investment advice. All results are hypothetical and for illustrative and educational purposes only. We cannot guarantee the accuracy or applicability of results for your specific situation. The data input and output are limited in scope for purposes of simplicity, and may not address many real-world factors associated with actual investments. We recommend you speak with your tax and/or investment advisors or other qualified professionals for specific guidance relative to your individual situation.

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.