Turnkey Property in a Self Directed IRA

[Mark Senecal]

Hey BiggerPockets,

I have retirement money in a few places but they are mostly stock based.  Lately stocks have not been performing that well.  In an effort to diversify I would like to invest in real estate.  Turnkey properties seem to be a good entry level for someone who already has a 50 hour a week job.

Could I rollover one of my IRAs to a Self Directed IRA then use that money to invest in turnkey property. What are the risks? How should I structure this? Should I have an LLC? As you can tell I have a lot of learning opportunities ahead of me.

After getting my feet wet with this I am hoping to leverage the experience and invest in real estate full time when I retire in a few years.

I look forward to hearing your thoughts.

Mark

[Jaysen Medhurst]

Hi, @Mark Senecal, there's a whole forum category for Self-directed IRAs. You should definitely spend some time there.

[Mark Senecal]

Thanks @Jaysen Medhurst. I will go there now!

[Dmitriy Fomichenko]

@Mark Senecal Welcome to BiggerPockets! 

Setting up a self directed IRA and investing in properties can be a good way to diversify. However, like any other investments, you need to do your research, especially on how to set up and manage a self directed IRA, how to find a good turnkey company and select a property, etc.

When you invest with your IRA money, keep in mind that all investments, incomes, and expenses have to go through the IRA itself. So make sure you have enough reserves in the IRA, not just for the purchase of the properties, but also for any expenses that may arise, including maintenance, insurance, etc. In case the IRA is short on cash, only non-recourse financing is available to an IRA, but that's a whole different topic.

I would recommend talking to a professional who can walk you through the process. BP also has a lot of information on this topic, and if you have any questions, feel free to post and ask others!

[Jay Hinrichs]

@Dmitriy Fomichenko that's great advice about reserves.. I have seen this fubar people when they spend 95% of their IRA funds on a rental then have unexpected expenses and do not have the reserves and have already contributed to it for the year.

what do they do in that circumstance Dmitriy is there a hard ship they can use .. or what ?

[Dmitriy Fomichenko]

@Jay Hinrichs

there could be few options: make additional contribution to an IRA, rollover funds from another retirement account, bring on a partner, liquidate ... but for some people in some circumstances those options might not be feasible so it is best to plan ahead and have adequate reserves.

[Brian Eastman]

@Mark Senecal

It sounds like you are headed in the right direction. Using a self directed IRA is a diversification play for the IRA. The IRA is treated in the same fashion as any other for tax purposes, but rather than being limited to what Wall St sells, you can invest in non-traditional assets such as real estate.

As someone who is busy, turn-key real estate or brokered mortgage notes would be good avenues to research. By leveraging the expertise of a professional, you can minimize your investment of time and energy in putting your IRA capital to work. Of course, it all depends on the quality of the partner(s) you choose to invest with.

Within the IRA realm, there are two business models.

IRA Custodians (generally trust companies) can hold an account and document that account's investment into non-traditional assets. They hold the funds, sign the documents, cut the checks for acquisition & expenses and receive the income - all for the benefit of the IRA and at your direction. Depending on what you are doing and how "turn key" it really is, this can work... or the paperwork and processing delays can be a real barrier to efficiency. Basically, the less interaction with the investments, the better.

A Checkbook IRA LLC or Solo 401k will put you directly in control of the funds and eliminate the 3rd party layer. If your portfolio will be more interactive, this is generally the more effective route.

So, get out there and do your research on plan formats and turnkey providers.  Be sure to do diligence on the providers you choose to work with.  Have your tax professional put a set of eyes on what you plan to do.  It can be a great way to get results for your retirement savings if executed properly.

[Lane Kawaoka]

@Mark Senecal

Turnkeys or rentals in general are not that great in SDIRAs because you lose the depreciation benefits and ability to leverage. You can get non recourse loans but the terms suck.

[Darren Eady]

@Mark Senecal

I've seen around 1000 clients self-direct their IRA funds and buy performing properties and performing notes.  

Two cautions: don't borrow through your SDIRA. People will lend to you so you can leverage your purchasing power, but I've seen people get stuck in those loans without being able to contribute more to their IRA but a needing to fix up an IRA owned property.

Don't buy non-performing assets in your SDIRA.  Same issue as above.  Tax liens, non-performing notes or vacant properties would all be really bad ideas to invest in with your retirement funds.

Also, when you purchase performing properties, leave some maintenance money in your SDIRA for repairs or vacancies.  With performing notes (I could spend some time talking to you about how these are perfect for your SDIRA), you don't need a reserve in your account, you can use the full amount and collect 12% annually.

For performing properties, I would suggest you start speaking with @Chris Erwin.  I get mine from him and have built up enough monthly cash flow to live off.

[Jay Hinrichs]

@Mark Senecal@Darren Eady

Darren  one should also keep reserves if one is buying notes.. Not all notes pay as we know,  you can't be 100% perfect so you need to have some reserves incase you need to pay for a foreclosure or you take a property back and have to rehab it.. if you take one back you will have in most cases extensive rehab to do... So in my mind a prudent SDRA investor keeps a very nice reserve regardless of it being a note or a rental.  Doing either with no reserves could really be a problem.

For instance for note holders/

1. what if your borrower neglects to pay property tax's you as note holder must pay them if you don't want to be wiped out at a tax sale.. I see this as a very weak link in most investors who buy performing notes they neglect to check taxs yearly to make sure their trustor or mortgagor is actually paying them.. Unless of course you set up escrows from borrower to pay these.. but most private TD's dont' do this as its complicated.

2. Foreclosure costs... we know that all notes can't be perfect and this will happen over the course of time to some.. so don't want to have No funds in your SDRA to pay these costs and it varies by state.. If your in a Mortgage state like Alabama its expensive.. if you in say Mississippi or Georgia is cheap and quick..

I know some lenders talk about getting deeds in Lui at the time the loan is made however this is not legal and can be challenged very easily by the borrower so that's not recommended at all.

So in my mind reserves are a must if your going to do anything with real estate in SDRA.

[Chris Erwin]

Hello @Mark Senecal. There is some great advice posted in response to your post. As @Darren Eady mentioned, performing properties are a great investment as you could get the potential appreciation over time, as well as the monthly rents collected. It sounds like you are no stranger to investing, so I won't go into the speech about risks associated with investing in real estate. Our group has several investors that enjoy double digit returns on their investments. I would like to discuss this further with you. When would be a good time to talk?

[Darren Eady]

@Jay Hinrichs

My performing notes don't have any of those issues. 

Escrows included, POA, typically take back a non-performer. Most note buyers don't live in this perfect world though.

I think it's a great idea to hold reserves of buying almost anything except performing notes with me only. 

[Jay Hinrichs]

@Darren Eady to funny Darren... the POA to take back a note won't stand up if challenged.

but I love the confidence.. what happens when the tenant trashed the house and the investor bails who fix's it up.. do you do that personally ?    \

and my comments are general in nature not specific to your loan product.  LOL

Even though BP rules prohibit shameful plugs for your won deals  LOL

[Darren Eady]

@Jay Hinrichs

That sounded a little cocky, huh? The POA works great when needed. It was my attorney's idea a few years ago and out of 4000 loans I took back about 30 through POA and only 1 of those borrowers called to see why they lost their home and wanted to buy it back . . . But didn't end up having the cash. In my under $50k niche, the small loan amount works both ways . . . Not big enough to spend the time to foreclose and not big enough for a borrower to fight either (if they had the means and time)

I'm headed out to Lake Powell right now. I'll call you when I'm back in town Jay!  Still working on the fund we spoke about. 

[Jay Hinrichs]

@Darren Eady  Roger that.... had to give you a hard time !!!!  Mod's were all over me when I mentioned anything about my personal business   LOL..

enjoy.. you could be here in Oregon 60 and grey drizzle.

[Jeff Rabinowitz]

I have seen "magic houses" advertised before--those houses that never have any vacancies and never need any maintenance thus guaranteeing a phenomenal ROI. It seems one can also invest in "magic notes"--those that have payors who never skip a payment. Even when they are faced with tragic situations the payor's first priority is making the payment on the investor's note and they always fulfill all their obligations. Do people still sell bridges?

[Denise Evans]

Alabama uses mortgages, but we are considered a hybrid state. Most states that use a deed of trust allow non-judicial foreclosure, which is cheap and easy. Most states that use a mortgage require judicial foreclosure, which takes a long time and is expensive. Alabama uses an instrument called a mortgage, but it legally transfers title immediately to the lender. Sort of like the deed of trust immediately transfers legal title to the trustee. IIn Alabama, if the borrower makes all payments, then the title "defeases" or "jumps back" to the borrower. If the borrower defaults, then under the power of sale in the mortgage instrument, the lender can sell the property on the courthouse steps, exactly like a deed of trust state.

The one deterrent in Alabama is the one year right of redemption. The borrower (or someone claiming under the borrower) can force the current owner to sell the property back to the borrower at any time within one year after the foreclosure. There is a different rule for mortgages signed after January 1, 2016 (I'll put that at the end, so it won't be a distraction here) The redemption price tag is the winning bid amount at the foreclosure auction, plus some additional charges. If the auction bid amount was $100,000 and the investor then sells to someone else for $125,000, and the borrower wants to redeem, it is $100,000, plus the additional charges, not $125,000 plus additional charges.

The additional charges consist of interest at 7.5% per year, the VALUE of all permanent improvements made after the foreclosure auction, and the cost of all casualty insurance premiums. 

In a May 13, 2016 Alabama Supreme Court decision, the investor built homes on unimproved subdivision lots that had been foreclosed upon. The borrower wanted to redeem. He argued about having to also pay for the value of the new subdivision homes. The court said, "Too bad, that's the rule," but they used a lot more words.

Older cases say that "permanent improvements" also means any repairs done to the property.

If the investor rents the property out, and the borrower redeems, the investor can keep all rents collected up until the date of redemption.

If the investor also owns other liens against the property, such as buying up old judgment liens against the borrower, then the borrower must also pay the full payoff amount of those liens in order to redeem.

If the owner of the real estate also owns the note that gave rise to the mortgage that was foreclosed, then the borrower must pay the full balance of the note in order to redeem, not just the amount bid at the foreclosure. This occurs when a note holder credit bids the property itself because there are no other bidders. It also happens when an investor buys at the foreclosure auction, but then negotiates with the note holder to buy the promissory note, also.

If there were outstanding junior liens at the time of foreclosure, and the borrower redeems, then all those liens revive against the property. A borrower can't launder their title by letting their property be foreclosed and then redeeming it right away. As a result, most borrowers are never able to redeem. If someone is going to redeem, it's usually going to be a commercial property, or a family farm, or something owned by a church.

Change in law for mortgages signed after January 1, 2016: If the borrower claimed a homestead exemption for the ad valorem tax year immediately preceeding the auction, then the lender must give certain required notices to the borrower, and must also publish those notices in the newspaper foreclosure notice. If that is done properly, then the borrower has only 180 days to redeem. If it was not done properly, then the borrower has as long as two years to redeem.

[Jay Orlauski]

@Mark Senecal I have found this video to be very educational - it discusses the advantages and limitations of the self directed IRA how to use it for real estate investments. I had a hard time getting any good info about it and she breaks it down pretty good in this video:

https://www.youtube.com/watch?v=z15aanCJ4sA

hope it helps

[Mark Senecal]

Great responses!  Thank you all.  The subject of reserves is a recurring theme in the responses.  That makes total sense.  Is there a rule of thumb on what to have in reserve?  Thanks again.

[Dennis Weber]

@Mark Senecal

These guys are giving you great advice. But they're younger than us and didn't mention this. The Roth Factor. I moved a considerable amount from a work account to checkbook sdira. Invested almost all of it in tax liens and notes.  All these investment did unusually well. Great!  No cap gain taxes!  Oops!  Now that I want to draw money out I'll have to pay income tax. Greater expense than cap gains. 

Don't know if I can convert before investing it again. But needed to make you aware before deciding on your plan. 

[Mark Senecal]

@Dennis Weber - I am glad you brought this up. I really like the Roth IRA. Unfortunately the rollover will be from tradition IRS established before the Roth IRA was born in 1997. So my thinking is two SDIRAs are needed. One rollover and one Roth for new contributions. Does this strategy make sense?

[Dennis Weber]

let's ask @Brian Eastman

[Brian Eastman]

@Mark Senecal

It probably does not make sense to start a new Roth IRA for the purposes of combining with a Traditional IRA.

Say you have $100K in Traditional Funds and you contribute $6500 (the max if you are over age 50) to a new Roth.

You could setup two IRA plans and use them to jointly purchase a property, but you would be locked into the equity ratio of the initial purchase, which would be something like 93% Trad to 7% Roth (depending on purchase price, and the need to keep reserves in both accounts). You could not easily transfer equity from the traditional to the Roth in the future. So new contributions to that Roth would need to be invested elsewhere.

You could consider a Roth conversion on the existing traditional IRA. Whether that would benefit you is a pretty complex analysis and something you should discuss with your licensed tax advisor.

Investing in real estate does not really change the dynamic of Traditional vs Roth. It is just a different asset class that can be invested in with either type of IRA funds.

[Mark Nolan]

@Mark Senecal

It sounds like you would like to use your retirement funds to invest in real estate which you would manage and take a salary for doing so. If yes, then look into the ROBS 401k as it will allow one to invest his or her retirement funds in his or her own business provided certain rules are followed.