Dead simple legal structures to use IRA in RE?

10 Replies

What are the simplest ways that someone can invest IRA capital in RE? Can they make private loans with or without a lien, invest using their own name, a limited partnership, etc? If LLC, does the money have to be passively invested, or can the LLC be closely held? Bring on your solutions!

@Seth C.

IRA capital can be used to invest in real estate in the variety of ways: single family rentals, commercial, in the US and out of the country, you can invest in tax liens and deeds, you can do hard money (or private) lending out of your account to other investors, etc. etc.

In order to do so you need a self-directed IRA. You can use a custodial account or if you wish to have more control special purpose LLC can be utilized to gain checkbook control and minimize custodian fees and eliminate their involvement in the investment.

If you are self-employed or own a small business your best option would be self-directed Solo 401k plan, which comes with number of features that are not available with self-directed IRA, and you don't need an LLC to gain checkbook control and custodian is not required.

This topic have been discussed here on the forum many times, in length... so I suggest to start you search the forum for the related keywords.

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@Seth C.

I like to invest my IRA in promissory notes which generally pay between 8 to 12 percent and are secured with real estate-always first position.

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Hello Seth,

Buying properties through your self directed IRA is not too dissimilar from buying properties outside of an IRA. Below are some of the major points to be considered:

  • There are very few restrictions as to the type of real estate as long as it is an investment property.
  • Properties purchased through your IRA can be financed. The loan must be a "non-recourse loan". Search "ira non recourse loan" and you will find several.
  • You can use 1031 Exchanges with properties held in the IRA.
  • You can put properties in a LLC within in your IRA for protection.
  • You do not hold title directly; a custodial service holds title for you.
  • The custodian will be the entity signing the closing documents.
  • All actions must be at arms length. This means:
    • You must use a property manager; you cannot manage the property yourself.
    • You may not personally do work on the property; a third party has to do it and the invoices paid by the custodian or the property manager.
    • You may not mix personal and IRA funds or the entire transaction may become an "early withdrawal" from your IRA and taxed as such.
    • You must report the market value to the custodian each year.

Rental income flows into your IRA, which you can utilize according to applicable IRA rules. The paperwork is not that different from normally held real estate and the only taxable event would be if you financed the property and then sold it at a profit. The financed portion of the gain would be subject to what is called the Unrelated Business Income Tax or UBIT.

Unrelated Business Income Tax (UBIT)

In most cases, people hold investment properties in their IRA for the income stream, not for flipping, so the UBIT is not typically a factor. However, should you choose to sell a financed investment property, there is a tax due on the financed portion of the gain. For example, suppose you decided to sell a property that was 60% leveraged and after deducting the cost of sales and other expenses you had a UBIT taxable gain of $20,000 and your marginal tax rate at the time of sale is 20%. The tax on the gain would be:

UBIT = $20,000 x 60% x 20% or $2400

Remember that UBIT only applies to financed properties that are sold. Note that if the loan is paid off 12 months prior to the sale, there is on tax since you only pay tax on the leveraged portion of the gain. Also, if you have paid down the loan to the point where you will have to start paying a meaningful amount of UBIT tax, it may be better to consider a 1031 Exchange.

Seth, I hope this helps.

 @Eric Fernwood : Can the custodian/worker be anyone? Ie, it sounds like it would work to create a multi-member LLC with myself as the managing partner to manage an asset for an immediate family member, no need to have a series LLC? There would be an external management co, but I would like to be able to personally drive a nail.

Hello Seth,

The following is my understanding based on clients statements. This does not make it correct and you need to do your own research before you do anything.

  • You have to buy property through an IRS qualified custodian. Here is one such custodian.
  • The property must be held by the qualified custodian, not you.
  • The property must be managed by a professional property manager; you cannot manage it yourself.
  • You cannot do any work on the property yourself. All work on the property must be performed by third parties (contractors or the property manager) and paid though the custodian. You can not pay for anything from personal funds. Everything must flow through the custodian.
  • I believe you can put the property in a series LLC. but LLC is inside the IRA.
  • If you mix any IRA funds with personal money, all the funds withdrawn from the IRA may be considered an early withdrawal.

Seth, this is not something to guess at. You need to fully investigate all the rules and regulations before you do anything. I recommend you start by talking to a qualified custodian.

Hope this helps.

 @Eric Fernwood :

I definitely agree, this sounds like it require a proper cpa/lawyer opinion. People do invest as private investors in larger llc offerings using their ira, so certainly the llc itself does not need to be within the ira, but the shares you own do. For the rest, I will seek further info!

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