Using an IRA for downpayment funds?

Question

This may not be a "creative RE Financing" topic - so please forgive me!

I'm just starting out to build my portfolio -- (I have a SFH that is LT rental and have done that kind of thing for years...but moving on into more multi family, and more RE properties each year).

Can I take money out of my traditional IRA account to use for a downpayment?
What are the implications of doing so?

Thank you for offering your advice on this.
Tanya

Dmitriy Fomichenko · Answer

@Tanya Maslach,

When you take a distribution from an IRA, you are subject to ordinary income tax, plus penalties, if you do it before reaching retirement age.

Alternatively, you can convert your IRA into a "Self-Directed " IRA and buy investment real estate inside your SD IRA. Remember that you would not be investing personally but rather your IRA, which is a separate legal entity. All investment income must go back to the IRA, and all investment-related investments must be paid from the IRA. Generally, all passive income in an IRA would be sheltered from taxes, however if you are using leverage then portion of the income derived from the financed portion of the property would be subject to Unrelated Business Income Tax (or UBIT). IRA would be responsible for paying this tax.

Basit Siddiqi · Answer

The implications of taking money from a retirement account(if not Roth) is that the distribution will be considered income and potentially subject to a 10% penalty.In my opinion, real estate investments and securities within a retirement account are used towards your later years.So it doesn't matter whether it is in one bucket or the other.If you are subject to the 10% penalty, I would only take out a distribution if you strongly beleive your return from real estate will be several percentage points higher than what you can invest in with your IRA.For example, if your return within the IRA is about 8% and you can make 10% in real estate, I would consider doing the distribution because the extra return will pay off the penalty over a few years.Best of luck

Tanya Maslach · Answer

Love all the comments and thoughts here.   Thank you everyone @Ashish Acharya @John Bowens   @Gino Barbaro  @Jacqueline WrightWe'll be staying out of our Traditional and Roth IRAs then for this.And we aren't ready for and aren't qualified for a self directed IRA at this time, so we'll not go that route.The loan out of the 401K is interesting.  This would be a non recourse loan (for a downpayment on a new construction property) so we wanted to consider something other than our HELOC (that has a variable interest rate attached to it). The HELOC has a 8.5-9.0% rate on it, so we'll do the math on the penalties for dipping into the 401K for the down payment vs the HELOC>

Tanya Maslach · Answer

Thank you @Basit Siddiqi !!

Ashish Acharya · Answer

@Tanya Maslach can use the 60-day rollover rule to avoid penalties, but funds must be replaced within 60 days. Unlike a 401(k), IRAs don’t allow loans. A self-directed IRA (SDIRA) can invest directly in real estate to avoid these issues.

If you have 401k, you can take out loans without tax impact. This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

Gino Barbaro · Answer

@Tanya Maslach

There are tax implications, and a penalty. I would take a look at Self directed IRAs. We use https://www.advantaira.com/

I ended up taking all the funds from my IRA accounts, paid the 10% penalty, and with Cost Seg and Real Estate Pro status, was able to avoid paying taxes. Not a wise thing to do for everyone, but for me, it was the thing I could have done. I had access to my money for an amazing deal, and I was out of the IRA system. It may have been different if it was a Roth IRA.

I would also consult your CPA for his advice

Best

Gino

Jacqueline Wright · Answer

If you want to leave your IRA intact and avoid penalties or taxes, consider other options such as:

• HELOC (Home Equity Line of Credit): If you own property with sufficient equity, a HELOC can provide funds for a down payment without tapping into your IRA.
• Personal Loan: Depending on your credit, a personal loan may be an alternative.
• Seller Financing or Private Lending: Look into creative financing options for real estate investors, such as seller financing or private lenders, which can help with down payments without needing to use your IRA.

John Bowens · Answer

Excellent comments above. It sounds like you are looking to use Traditional IRA money to purchase a rental property? If so, here are some thoughts to consider as you research further:

1) When your IRA or Solo 401k borrows money, it must be a non-recourse loan, and there are lenders out there that will loan to an IRA or Solo 401k, you just have to reasearch. The reason you have to obtain this special type of financing is because the tax code provisions (IRC 4975) do not allow you to personally guarantee debt that your IRA or Solo 401k takes on.

2) It was referenced above UBIT, which is a special tax on the portion of the after expenses and depreciation, that is attributed to the debt financed percentage of the property. Keep in mind, that is NET income, so with enough operating expenses, and depreciation, you might wipe out any income, and thus no UBIT, you will just need to run your numbers. Example, you purchase property for $150,000, and borrow $100,000, with $50,000 DP from IRA. 2/3 of the NET income will be subject to UBIT. 3) Now, what about a Solo 401k? Solo 401(k)'s in most instances are exempt from UBIT as it relates to Debt Financed Income. You might consider rolling your Traditional IRA over into a Solo 401k and purchasing a property with debt, instead of IRA. Now, here is the catch: 1) You have to have to be self-employed, maybe an LLC or S-Corp, or just sole prop, but you have to have earned income in that business. This means you are paying medicare social security tax on the income. You also can't have any W-2 employees, with the exception of you and your spouse, and maybe business partners that have at least 5% ownership.

You should work with a CPA or tax professional that can help you with structuring your business properly first.

Hope this helps, great questions!!!!

Tanya Maslach · Answer

This is SO helpful. 😊

Using an IRA for downpayment funds?

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