Solo or Independent 401K

The True Path to Total Financial Freedom              

Power Chapter

The "Hidden" Tax in Your IRA That Is Easily Avoided

As every Real Estate Investor knows, LEVERAGE is your most powerful tool.  Some people call it OPM (Other People's Money).  Some call it OPIUM (Other People's Idle, Underused Money).  Some call it loans and some call it leverage.  Regardless of your name for it, it is the SINGLE most powerful tool that a real estate investor has.  It's the single most powerful tool used INSIDE a retirement plan, as well as in your own personal holdings.  Even though it's the most powerful tool, Roth and Traditional IRAs - BY LAW - punish you for using it.  Worse yet, your custodian will skirt the issue and avoid telling you how easy it is to eliminate this tax from affecting you!

Borrowing Money Creates Tax

Annie Investor has $500 in her Roth IRA.  She can borrow $80,000 for a fix-n-flip from a Private lender at 10% per year..  Her $80,500 purchases and rehabs a property that she sells for $110,000 in four months. Annie must pay her lender back $82,666.67.

Her sale $110,000 (net of all costs) less the loan of $82,666.67 leaves her $27,333.33!  That's a pretty nice profit starting with just $500.00.

Unfortunately, that's not her profit.  She owes tax, and she owes a lot of it. 

The main disadvantage of IRAs, both Roth and Traditional, is the tax that's generated when an investor uses their most powerful tool - LEVERAGE!

The following explanation demonstrates the negative impact of UBIT, and how it affects the return for the investor.

For a full explanation of UBIT, UDFI, and their effect on leveraged transactions, get the book "Live Tax Free Forever."

Live Tax Free Forever



Normal people (you and I) call it loan-to-value, the IRS calls it UDFI.  This why:  The IRS wants to know "Did you have income?"  Annie had $27,333.33 in income.  Next they ask "Did you use any DEBT to generate that income?"  Yes!  She borrowed $80,000.  They then want you to figure out the percentage of Debt (loan to value) used to generate that income (UDFI).  Annie divides $80,000 by $80,500, so her loan to value (UDFI) is 99.38%.  That means she must pay tax on 99.38% of her profit!  Her profit is $27,333.33.  $27,333.33 x .9938 is $27,163.86.  Annie must pay tax on $27,163.86.


UBIT stands for Unrelated Business Income Tax.  This is the tax on transactions that exist in an IRA.  This tax rockets to 39.6% after $12,400 of profit.  Compare that to corporate income tax.  You have to earn $10 Million in your corporation before you pay 35%.  This is a pretty harsh tax!  Without going into the entire calculation, Annie must pay $9,119.60 in UBIT!


That's a third of her profit!  That's a pretty big bite for a fairly small transaction.

Eliminate UDFI and UBIT

Annie doesn't get to keep $27,333.33.  She has to pay $9,119.60 in UBIT.  OUCH!  That's a third of her profit!  Out of her $27,333.33, she only keeps $18,213.73.

Wouldn't it be great if Annie could keep all the money she earned?


Using a solo 401K completely ELIMINATES UDFI and UBIT in this instance.  401Ks do not incur UDFI on  transactions financed by third parties!*  Annie gets to keep her entire $27,333.33 for doing EXACTLY THE SAME transaction in her 401K versus her IRA.

     401K                           IRA $27,333.33                 $18,213.73


Knowing the impact on a client, why would a financial institution recommend an IRA instead of a 401K?  Which would you want to use?

Furthermore, there is no reporting requirement for smaller 401Ks.  Annie would not have to fill out a 5500EZ until her account reaches $250,000, eliminating filing fees, reporting fees