Investing in Real Estate Through Retirement Accounts

[Randy Smith]

After spending a few years investing out of state in long term rentals, I realized that I would have to accumulate up to 100+ houses at the infamous “$100/door” target to completely decrease my dependance on my W-2 income. The path to five doors was an arduous one, and I couldn’t imagine the time, energy, and effort it would take to hit my new target. Like many others, I decided that investing in multi-family would be the best route to get there, and my research showed that the best way to do that would be as a limited partner in a syndication. Unfortunately, I had spent all our capital on buying and renovating our other “passive investments.” So, where would the capital come from to test my new theory?

Introducing Self-Directed IRAs

A self-directed IRA is an individual retirement account that allows you to take advantage of all the same tax benefits of a traditional IRA, but it also allows you to have more control of your funds AND you can invest in alternative investments like real estate and real estate syndications. While there are a few hoops you must jump through to leverage a self-directed IRA, this option opens real estate investing to anyone that already has an IRA or an old 401k from a previous employer.

So How Does It Work?

At a high level, you'll need to transfer your funds from your existing IRA, 401k, or other retirement account to a self-directed IRA custodian. Your funds will then be available to invest in real estate transactions or any other type of alternative investments. I suggest finding a self-directed IRA custodian that will assign a dedicated account manager to handle your account as you will likely want to have someone holding your hand as you do your first few transactions.

It's not the goal of this article to tell you all the details of this type investing, but it's more to inform you that this is an option for you to consider. I would encourage you to research a self-directed IRA custodian and be sure to do your due diligence before moving forward.

By leveraging my funds from a former employer 401k plan, I was able to invest in three different syndicators across multiple markets which gave me the confidence to invest in many more opportunities over the past two years. While I won’t be able to have these funds deposited into my regular checking account until I reach retirement age, I do have more control of the funds, and I get to continue my education and experience in various real estate opportunities I wouldn’t have access to without this strategy.

[Greg Scott]

It should be noted that if you have a traditional self-directed IRA, you may end up paying more tax via this strategy than if you paid the penalty and then invested in real estate. If you invest successfully, UBIT during the investment plus ordinary income taxes when you pull the funds out can result in lower total returns than taking the up-front hit and getting your money out.

A Roth SDIRA is a different animal.

[Taylor L.]

Quote from @Greg Scott:

It should be noted that if you have a traditional self-directed IRA, you may end up paying more tax via this strategy than if you paid the penalty and then invested in real estate. If you invest successfully, UBIT during the investment plus ordinary income taxes when you pull the funds out can result in lower total returns than taking the up-front hit and getting your money out.

A Roth SDIRA is a different animal.

 My experience with my own SDIRA has just been a pain in the neck, primarily because of UBIT. It was difficult to find a CPA who could prepare a 990T for a reasonable price, then working with the Trust company to get it filed and paid was another big hassle. I put up with it for a good few years, but I've decided once the current holdings are liquidated I'm done with the SDIRA.

I think are probably a lot of investors using SDIRAs who are not filing 990Ts and are not paying UBIT, just give the almost total lack of discussion & resources on the topic.

[E. C. "Stony" Stonebraker]

I agree that many, if not most, of the SDIRA discussions do not include any info about the UBIT requirement and 990T filings. One alternative is to form an entity which will sponsor a solo 401k and roll over IRA funds into the solo 401k. That eliminates the UBIT obligation, allows much larger contributions, and has numerous other advantages. There are pros and cons to this, but it offers a way to invest in real estate and other alternative asset classes. Be sure to speak with CPAs and attorneys who are experienced real estate investors themselves. It will nearly always be better to get professional advice before you invest and find out what mistakes you've made based on advice from the internet.

[Dmitriy Fomichenko]

Quote from @E. C. "Stony" Stonebraker:

I agree that many, if not most, of the SDIRA discussions do not include any info about the UBIT requirement and 990T filings. One alternative is to form an entity which will sponsor a solo 401k and roll over IRA funds into the solo 401k. That eliminates the UBIT obligation, allows much larger contributions, and has numerous other advantages. There are pros and cons to this, but it offers a way to invest in real estate and other alternative asset classes. Be sure to speak with CPAs and attorneys who are experienced real estate investors themselves. It will nearly always be better to get professional advice before you invest and find out what mistakes you've made based on advice from the internet.

This is not exactly accurate: just forming "an entity" will not make you eligible for Solo 401k plan. Legitimate self-employment activity or active business that generates "earned" income and absence of full time employees - that is how someone can qualify for a Solo 401k plan, you don't have to have an entity. I agree with you however, that if eligible, Solo 401k has several major advantages over SD IRA. 

[Darryl Bull]

Is taking a loan from a qualified IRA a good option? Sounds like this is feasible based off of what I am reading on the IRS website here. See below.

"

Under what circumstances can a loan be taken from a qualified plan?

A qualified plan may, but is not required to provide for loans. If a plan provides for loans, the plan may limit the amount that can be taken as a loan. The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less.

For example, if a participant has an account balance of $40,000, the maximum amount that he or she can borrow from the account is $20,000."

[Dmitriy Fomichenko]

@Darryl Bull,

It is not possible to take a loan from an IRA. The IRS states the following:

"Loans are not permitted from IRAs or from IRA-based plans such as SEPs, SARSEPs and SIMPLE IRA plans. Loans are only possible from qualified plans that satisfy the requirements of 401(a), from annuity plans that satisfy the requirements of 403(a) or 403(b), and from governmental plans."

[Account Closed]

There is a use case for SDIRAs for REI but buying syndications or actual rentals is not the best way. You can buy anything that generates a regular 1099 income rather than K1. Example notes, note fund, hard money lending fund, private loans etc. In that case the interest is tax deferred but the rate you pay when you withdraw may be lower than your current rate or at least the same. Also you get no pass through tax benefits like depreciation anyway on these investments.

You should never own actual rentals where you are responsible for upkeep and costs in an IRA because you have to use only IRA funds for all repairs etc and theoretically that's an unlimited number. You maybe forced to liquidate if you dont have enough reserves. Plus there's UBIT issues. Syndications are not quite as bad but a good syndicator tries to be as tax advantaged as possible any way so better in taxable accounts. You get pass through depreciation and capital gains which is lower than the taxes you will pay if you keep in IRA and withdraw later. I guess the one MAJOR exception is if you have a Roth SDIRA (is there such a thing?)

[Jeffrey Dixon]

Darryl,

You cannot take a personal loan from any IRA. 401k plans allow personal loans to be taken from them.

[Chris Seveney]

Quote from @Taylor L.:

Quote from @Greg Scott:

It should be noted that if you have a traditional self-directed IRA, you may end up paying more tax via this strategy than if you paid the penalty and then invested in real estate. If you invest successfully, UBIT during the investment plus ordinary income taxes when you pull the funds out can result in lower total returns than taking the up-front hit and getting your money out.

A Roth SDIRA is a different animal.

 My experience with my own SDIRA has just been a pain in the neck, primarily because of UBIT. It was difficult to find a CPA who could prepare a 990T for a reasonable price, then working with the Trust company to get it filed and paid was another big hassle. I put up with it for a good few years, but I've decided once the current holdings are liquidated I'm done with the SDIRA.

I think are probably a lot of investors using SDIRAs who are not filing 990Ts and are not paying UBIT, just give the almost total lack of discussion & resources on the topic.

 This is why many go to private lending / notes with a SDIRA. You can avoid UDFI/UBIT since you are not borrowing. If you invest in a syndication, its important also to understand their structure and see if you are subject to the taxes. We arranged our fund to avoid UDFI/UBIT and we believe its been a game changer for many to not have to deal with the tax consequences. 

[E. C. "Stony" Stonebraker]

Quote from @Dmitriy Fomichenko:

Quote from @E. C. "Stony" Stonebraker:

I agree that many, if not most, of the SDIRA discussions do not include any info about the UBIT requirement and 990T filings. One alternative is to form an entity which will sponsor a solo 401k and roll over IRA funds into the solo 401k. That eliminates the UBIT obligation, allows much larger contributions, and has numerous other advantages. There are pros and cons to this, but it offers a way to invest in real estate and other alternative asset classes. Be sure to speak with CPAs and attorneys who are experienced real estate investors themselves. It will nearly always be better to get professional advice before you invest and find out what mistakes you've made based on advice from the internet.

This is not exactly accurate: just forming "an entity" will not make you eligible for Solo 401k plan. Legitimate self-employment activity or active business that generates "earned" income and absence of full time employees - that is how someone can qualify for a Solo 401k plan, you don't have to have an entity. I agree with you however, that if eligible, Solo 401k has several major advantages over SD IRA. 

You are correct.  That is why I didn't say forming an entity makes you eligible for a Solo 401k.  You have to have a legitimate business that can sponsor a Solo 401k.  But it is a normal step to do so.  And as others have said here, there are other real estate related investments one can make with DS IRAs without incurring the UBIT/UDFI issues.  As always, be sure to check with professionals who know this business and aren't just looking to sell something.