PRIVATE LENDER'S SELF DIRECTED IRA..NEED SOME CLARITY HERE..

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PRIVATE LENDER'S SELF DIRECTED IRA..NEED SOME CLARITY HERE..

Metairie, LA · Member since 2013 · 13 posts · 2 votes

Ok, I've read that many private lenders lend out of their self directed IRA's to investor's for a return on their money..However I came across this article and now I'm totally confused..Self Directed IRA companies say one thing this article says another...Please click on the link below to view and if anyone can help, it'd be much appreciated..Thank you

http://www.figuide.com/why-you-shouldnt-invest-your-self-directed-ira-in-real-estate.html

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Jon Holdman

Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes

12y

1) Returns on rentals are often best with leverage. Its hard to get leverage inside an IRA. If you purchase with cash, you're reducing your returns.

2) If you do find a lender (they do exist) it will be at a low LTV and a high rate. And you'll pay UBIT on the debt financed fraction.

3) That "debt financed fraction" can actually increase over time as your basis is reduced by depreciation. At best it decreases slowly until you get quite far along with paying off the loan.

4) You can't work on the property. So the least little thing requires hiring someone to do the work. Some investors work this way, but not all. But with a property in an IRA, you have no choice.

5) When you do hire someone you have to get them a check. With most custodians you have to request a check. So you have to find a contractor who's willing to wait to get the payment. And that check request often involves a fee.

I think making loans out of an IRA is a much, much better choice. No UBIT. No issue with "doing work". At most a single check request then one sent back in when its paid off. Perhaps monthly payments.

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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
12y
You're talking about someone making a loan out of an SDIRA. The article is talking about buying real estate in an IRA. I agree owning real estate in an IRA is a bad idea. But you're talking about a completely different investment.
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Mike Bryant
Real Estate Professional · Lees Summit, MO · Member since 2013 · 57 posts · 21 votes
12y
This article explains all the reasons why it is MUCH BETTER to LEND out of your IRA than to actually BUY property in it. It's a relative nightmare to manage a property, pay repair bills, etc if you have an actual HOUSE owned by the IRA. A note however, is merely an asset with a defined stream of income, so long as the borrower doesn't default.
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Jared Lopez
Roseland, NJ · Member since 2014 · 13 posts · 4 votes
12y
The article you posted doesn't claim you can't invest in real estate using an IRA. From your description, it seems as if you are looking to loan money to a real estate investor. Either option is allowable. You can own a property in an IRA or you can lend money out of your IRA to a real estate investor.

This article states some negatives include not being able to use the property personally and custodial fees. If your IRA funds are in the stock market, you wouldn't be able to use the funds personally, the same would apply for real estate. The investment would need to be just that... An investment! Yes, there are administrative fees for this - but you are tapping into funds you normally wouldn't have access to.

He also point out that there are taxes based on the investment. Anything you pull out of an IRA is taxable income upon distribution, unless it is in a Roth account. The bottom line is if you are knowledgeable in real estate and think you can receive a higher return in purchasing investment properties as opposed to stocks, bonds, mutual funds, and CD's - why not use your IRA funds to invest in real estate?
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Jon Holdman
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
12y

1) Returns on rentals are often best with leverage. Its hard to get leverage inside an IRA. If you purchase with cash, you're reducing your returns.

2) If you do find a lender (they do exist) it will be at a low LTV and a high rate. And you'll pay UBIT on the debt financed fraction.

3) That "debt financed fraction" can actually increase over time as your basis is reduced by depreciation. At best it decreases slowly until you get quite far along with paying off the loan.

4) You can't work on the property. So the least little thing requires hiring someone to do the work. Some investors work this way, but not all. But with a property in an IRA, you have no choice.

5) When you do hire someone you have to get them a check. With most custodians you have to request a check. So you have to find a contractor who's willing to wait to get the payment. And that check request often involves a fee.

I think making loans out of an IRA is a much, much better choice. No UBIT. No issue with "doing work". At most a single check request then one sent back in when its paid off. Perhaps monthly payments.
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Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
12y
You are getting good feedback above as to the difference between *owning* the Real Estate vs *Making a Loan* to someone else for Real Estate.

I happen to disagree with the sentiment of some that a SDIRA is a 'bad place to hold real estate'. But, take that with a grain of salt as many of them have WAY more exerience than I and am probably much wiser.

My situation is that my SDIRA assets are at about a 20 to 1 ratio over my liquid cash on hand, and my 2 partners are in the same boat. So for US, it makes sense to make the most of what you have, and that is SDIRA funds in our case. I am not familiar with lending, but am with owning, so there is more comfort there for me/us.

I think Jared made some good points just above here too.

This is a response I posted a few weeks ago as to the idea that the UBIT and related taxes would 'eat up the profits'.

...................................................................................................

I know this topic has been covered here in detail before, so you might want to do some searching too.

I also use a SDIRA, but have not borrowed yet as the properties I am targeting are not 'eligible' in most Non-recourse lenders opinion, since they are houses converted to duplexes, pre 1940 construction, and under 100K purchase price. This is also my first year, so have yet to do the actual book keeping of what I am going to say below, so take it with a grain of salt! It is what I understand things to be from what I have learned here on BP.

As far as the whether to leverage or not..... to me it is a no brainier if you can. With that said, I look mainly at 'return on my investment'. Save you have 100K to invest and you can buy one property for 100K, or leverage it into 3 100K properties.

For rough numbers, let's say you make an 8% return with out appreciation, or 11% with appreciation, on the all cash unit. This might give you a NOI of about 8K, which is also your cash flow since there is no interest or principal payments. Hence your 8% return on the 100K.

If you leverage your money and get those 3 100K properties, looking at your return on your investment/equity, you might be at about 14% without appreciation or 24% with appreciation. This might give you a NOI of about 25K, but you then deduct interest of say 11K for a cash flow of 14K (hence your 14% return) and you also get depreciation of about 11K, leaving you a taxable income of 3K. It the UDFI is 33% in rough numbers, you only owe a tax of 1K.

This means by leveraging within your SDIRA, even AFTER you pay the UDIF, you have raised your return from 8% to 13% or almost 60% better. If you factor in appreciation, the return might go from 11% to 22%, or 100% better (doubling your return).

Again, these are just my THOUGHTS. Maybe @Steven Hamilton II could chime in and give his input on this line of thinking too.

...........................................................................................

Dan Dietz
[email protected]608-524-4899
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Jorge Caicedo
OP
Metairie, LA · Member since 2013 · 13 posts · 2 votes
12y
Thank you Jon and Mike! Much appreciated!
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Walt Payne
Real Estate Investor · Sebastian, FL · Member since 2014 · 812 posts · 432 votes
12y
@Daniel Dietz You can't depreciate SDIRA properties, so in your example the UDFI would be due on the financed portion of the income if I understand correctly. This would make the financing worth little more in income. If you have time to pay down the loans, it might help some in the long run. But then again the appreciation is also taxed as income if you sell it so reduce that part by the same 33%.
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Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
12y
Walt,

I have not had to deal with the whole UBIT in my SDIRA yet as we paid all cash for our first one, but plan to leverage upcoming ones. My understanding, which is just an understanding not experience, is that you CAN depreciate IF it is leveraged and you have the taxable gain from that leveraging. Again, I am not sure on that.

Dan Dietz
[email protected]608-524-4899
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
12y
Our company has set up about 2500 solo 401 k s and other IRA vehicles. YOu can buy real estate in your self directed accounts

We do it for clients 15 to 25 times a month....
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
12y
to correct my last post... WE provide lending opportunites to our IRA clients at the rate of 15 to 25 deals a month.. Our clients will sometime's buy the asset but we have little call for it.. Our clients prefer being the bank.. As its much easier in the long run you give up appreciation but a well structured note deal also mitigates down side and the trivails of owning a rental.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @Walt Payne:
@Daniel Dietz You can't depreciate SDIRA properties, so in your example the UDFI would be due on the financed portion of the income if I understand correctly. This would make the financing worth little more in income. If you have time to pay down the loans, it might help some in the long run. But then again the appreciation is also taxed as income if you sell it so reduce that part by the same 33%.

Walt,

You may take depreciation on the financed portion: IRS Publication 598

The appreciation will not be taxed as income if the property is still financed.
[email protected]224-381-2660
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Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y
@Daniel Dietz

Are your partners your spouse, parents or children?

If not and you all have a big wad in SDIRAs then instead of buying property in the IRAs become lending buddies.

Someone buys a property outside the IRA and the others finance it for them and they do the same when you buy. You can all benefit from the aspects of owning rentals outside of an IRA and all earn hassle free returns within them.
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Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
12y
Shaun,

The partners ARE my brother and dad. When you partner with 'dis-qualified' parties it must be done from inception, and can never change percentages etc...

I was under the impression that the 3 of us as a partnership can not lend to any of us outside of the SDIRAs. If I am hearing what you are saying right, my brother and I, OUTSIDE out the partnership (individually from each of our SDIRAs) could lend to each other and say I borrow from him to buy a unit and he borrow from me? Had not thought along those lines to be honest, but it is intriguing. I would love to hear you or others give a bit more detail of how that has worked.

I am working on lining up some non-family private lenders that may or may not be using their SDIRAs to lend to us, either within our outside our SDIRAs.

Thanks for the thought.

Dan Dietz
[email protected]608-524-4899
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @Daniel Dietz:
Shaun,

The partners ARE my brother and dad. When you partner with 'dis-qualified' parties it must be done from inception, and can never change percentages etc...

I was under the impression that the 3 of us as a partnership can not lend to any of us outside of the SDIRAs. If I am hearing what you are saying right, my brother and I, OUTSIDE out the partnership (individually from each of our SDIRAs) could lend to each other and say I borrow from him to buy a unit and he borrow from me? Had not thought along those lines to be honest, but it is intriguing. I would love to hear you or others give a bit more detail of how that has worked.

I am working on lining up some non-family private lenders that may or may not be using their SDIRAs to lend to us, either within our outside our SDIRAs.

Thanks for the thought.

Dan Dietz

Your brother's IRA may lend to you personally, and you personally may lend to your brother's IRA.
[email protected]224-381-2660
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Daniel DietzPro Member
Rental Property Investor · Reedsburg, WI · Member since 2011 · 1k+ posts · 857 votes
12y
@Steven Hamilton II or others,

I would assume if my brother and I lent to each other, the 'lending brother' could have NO interest in the property on a personal basis? Meaning if I lent him 100K from my SDIRA so he could personally buy 50% of a property, that I could not own the other 50% either with my own personal funds or from his SDIRA lending me personally the funds.

Dan Dietz
[email protected]608-524-4899
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Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y
Originally posted by @Daniel Dietz:
@Steven Hamilton II or others,

I would assume if my brother and I lent to each other, the 'lending brother' could have NO interest in the property on a personal basis? Meaning if I lent him 100K from my SDIRA so he could personally buy 50% of a property, that I could not own the other 50% either with my own personal funds or from his SDIRA lending me personally the funds.

Dan Dietz

Not an expert but generally speaking you could loan him money (i.e. be the bank) for a property he would own fully, or with someone else that was NOT a prohibited party (like your dad) but you would not be able to own any of it because you would be loaning money to yourself from your IRA which is prohibited.

He can then do the exact same thing for you.

Basically you can both own a property with the other ones IRA being the lien holder. If you buy comparable properties with comparable terms your overall returns should be similar to owning the 2 places jointly.

But you each get the benefits of owning investment real estate outside of your retirement accounts and none of the hassles of having it in there. You also get to put some amount of money from the loans into your IRA tax free.

Unfortunately your dad is SOL in this situation.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @Shaun Reilly:

Originally posted by @Daniel Dietz:
@Steven Hamilton II or others,
I would assume if my brother and I lent to each other, the 'lending brother' could have NO interest in the property on a personal basis? Meaning if I lent him 100K from my SDIRA so he could personally buy 50% of a property, that I could not own the other 50% either with my own personal funds or from his SDIRA lending me personally the funds.

Dan Dietz

Not an expert but generally speaking you could loan him money (i.e. be the bank) for a property he would own fully, or with someone else that was NOT a prohibited party (like your dad) but you would not be able to own any of it because you would be loaning money to yourself from your IRA which is prohibited.

He can then do the exact same thing for you.

Basically you can both own a property with the other ones IRA being the lien holder. If you buy comparable properties with comparable terms your overall returns should be similar to owning the 2 places jointly.

But you each get the benefits of owning investment real estate outside of your retirement accounts and none of the hassles of having it in there. You also get to put some amount of money from the loans into your IRA tax free.

Unfortunately your dad is SOL in this situation.

Only to non lineal descendants.

So NO you cannot be a part owner in the project.
[email protected]224-381-2660
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David Beard
Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
12y
When two or more people (non-disqualified parties) lend to each other from their SDIRAs, the IRS unfortunately has ruled that this is round-about self dealing and a prohibited transaction. It could be detected in an audit or through 1099 filings, I'd think. @Steven Hamilton II , I think you've stated in the past that folks have been busted for this kind of "mutual lending" activity.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @David Beard:
When two or more people (non-disqualified parties) lend to each other from their SDIRAs, the IRS unfortunately has ruled that this is round-about self dealing and a prohibited transaction. It could be detected in an audit or through 1099 filings, I'd think. @Steven Hamilton II , I think you've stated in the past that folks have been busted for this kind of "mutual lending" activity.

Yes, depending upon the degree in which it happens. It all depends upon facts and circumstances. I simply do not recommend it.
[email protected]224-381-2660
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Doreen Chaisson
Professional · Portsmouth, NH · Member since 2014 · 175 posts · 108 votes
12y
You are correct, the IRS considers this "reciprocal lending" and is a linked transaction to a prohibited transaction. You are each using the other's IRA funds for what is ultimately personal benefit. Most custodians will not accept reciprocal loans. If detected in an audit or tax filings, the penalties to the IRAs are hefty, including immediate distribution of the portion involved in the prohibited transaction, which is a taxable distribution, penalties for early distribution if you are under 59.5, as well as punitive penalties.
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Shaun Reilly
Landlord and Rehabber · Newton, MA · Member since 2010 · 2k+ posts · 877 votes
12y
Another reason why I love BP.

I had never heard of any issues with doing stuff like that. In fact the "lending buddy" idea was one told to me by an attorney that has done that with several colleagues with his SDIRA.

But his specialty is Real Estate, Business structures and litigation on Real Estate related issues and not Tax issues.
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Steven Hamilton IIPro Member
Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
12y
Originally posted by @Doreen Chaisson:
You are correct, the IRS considers this "reciprocal lending" and is a linked transaction to a prohibited transaction. You are each using the other's IRA funds for what is ultimately personal benefit. Most custodians will not accept reciprocal loans. If detected in an audit or tax filings, the penalties to the IRAs are hefty, including immediate distribution of the portion involved in the prohibited transaction, which is a taxable distribution, penalties for early distribution if you are under 59.5, as well as punitive penalties.

Doreen,

Actually the main penalty would be full distribution of the account involved.
[email protected]224-381-2660
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Stephanie Womacks
Temple, GA · Member since 2017 · 1 post · 0 votes
9y
In considering all the replies and being new to the sight, i had a question about the audit triggers. If i loaned $ to my aunt's r.e. investment co. Out of hubby's SDIRA, and in turn they (personally) paid 85% of our mortgage would this alert irs/dol and be deemed self dealing?
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Arthur Brenneman
Flipper · Fleetwood, PA · Member since 2017 · 4 posts · 1 vote
9y
Stephanie, I believe it would be. I have read it is where the money ends up. If there is a trail of you paying $30k from your SDIRA to someone, and they pay $30k to you in anyway (your bills, etc.) you are self dealing. The funds would need to be paid back from the person you loan the money to, straight to your IRA.
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George Blower
Retirement Accounts Attorney · Southfield, MI · Member since 2017 · 3k+ posts · 1k+ votes
9y
@Stephanie Womacks
It could be deemed a roundabout or straw-man transaction. In other words, you can't do indirectly what you can't do directly (i.e., use your IRA funds to pay for your home mortgage).
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