Self Directed IRA for Down Payment for Rental Property

20 Replies

So I'm trying to get myself up to speed on the requirements and details for SDIRA funding for real estate investments. If I were to use personal SDIRA funds for a 20% down payment on a buy and hold rental property and financed the rest with a conventional loan, would 20% of the rental income (the SDIRA's "share") need to go into the SDIRA? 

If so, would those IRA contributions be after-tax or tax deferred?

@Brian Knier

when financing investment property in an IRA you can't use conventional financing because you are not allowed to provide a personal guarantee. Therefore non-recourse financing must be utilized. This typically requires 40% down.

The property must be owned by the IRA 100% and 100% of the income and expenses will be attributed to an IRA also.

Reading a great and very detailed book on this matter right now. You can't get a loan for an IRA, nor can you manage the property or benefit from it (the IRA can). One option you can do is partner with another person or person's IRA so LO loan is needed. Read "The Checkbook IRA" by Adam Bergman. Long and very dry read for the most part, but very complete!

*No loan* as for after tax or tax deferred.. Would depend if your IRA is Roth or traditional. It can be a difficult assert to value, so may be better if IRA is Roth.

Originally posted by @S Taylor :

@Jaime Raskulinecz I am curious. How does one own a property jointly with an IRA? How would one set that up?

S Taylor, congratulations on finally making the move and posting your first comment on the forum! I see that you have been a member since 2009, what took you so long to finally participate in this awesome resource?!!

When it comes to IRA or 401k you are considered to be disqualified person, as such the IRS rules prohibit you to receive any benefit from your IRA directly or indirectly, providing to your IRA any services goods or facilities or otherwise be engaged in any transaction with your IRA. 

If you wish to stay out of trouble with the IRS do not attempt to commingle your personal funds with your IRA. If you are short on funds wait until you have enough or partner with another investor who is not disqualified. And be sure that you are working with qualified and experienced professional who can provide you with proper guidance (don't just trust everything you read on the internet), making a single mistake in your IRA will disqualify it, penalties are harsh up to 100% of the IRA balance. There are many legitimate ways to make your money work hard for you, being 'creating' or going into 'grey' area is not worth the risk.

@Steve C.

you probably misunderstood... you CAN get a loan for an IRA. But you personally can't guarantee it, that's why conventional loan won't work, you must use non-recourse financing. There are handful of lenders who offer this type of financing to IRAs, here is a list that I've put together over the years:

https://www.biggerpockets.com/blogs/2810/50272-lis...

And it doesn't matter if your IRA is Roth or Traditional, the rules are the same, no personal guarantee, loan must be non-recourse.

@Jaime Raskulinecz , let me ask you a question, here is a scenario:

I have $80K in my IRA and would like to buy a property for $100K. I happen to have $20K cash in my savings, this cash is not enough to invest in real estate on my own so I decide to partner with my IRA: 80/20. Is that permissible in your opinion?

Originally posted by @Steve C. :

*No loan* as for after tax or tax deferred.. Would depend if your IRA is Roth or traditional. It can be a difficult assert to value, so may be better if IRA is Roth.

 @Dmitriy Fomichenko I believe @Steve C. is referring to in-kind distributions, which when taken from a Traditional IRA, has multiple tax implications. For example: (a) RMD calculations and (b) the amount of taxable income created by the distribution. While there are IRS acceptable methods for asset valuation, investing with a Roth IRA for which there are no RMDs (unless inherited) and from which distributions are not taxable, does simplify things.

@Steve C. - is that your intent?

@Dmitriy Fomichenko Of course that scenario is not OK and would be a prohibited transaction since you would not be able to complete the purchase on your own and need your IRA to do it. I did say it had to be timed and structured properly. However, this is really NOT a grey area with the IRS and it is done all the time.

There are reasons why someone may want to partner with their IRA, or with another disqualified person's IRA. It is perfectly allowable as long as the investment is made simultaneously, the percentages of ownership never change throughout the life of the investment and there is no transactions BETWEEN the disqualified parties. All income and expenses should be split between the investors according to their ownership percentages.

As with all self directed investments, there are numerous rules to be aware of and to adhere to.

@Jaime Raskulinecz

It is very much a gray area. Nowhere in the tax code is there specific language discussing the ability of an IRA to joint-venture with a disqualified party. All that exists is interpretation. People speed on the highway "all the time", but only get ticketed when they get caught.

Per IRC 4975, there may be no direct or indirect benefit between an IRA and a disqualified party. It is very feasible with most of the scenarios we are presented with by would-be JV partners that some sort of indirect benefit exists, such as enabling one party to participate in a transaction they would not be able to do otherwise. @Dmitriy Fomichenko 's example is a common example of such.

It would be up to the IRS in the event of an audit to make a determination based on the specific facts and circumstances involved whether there was any such direct or indirect benefit.  That is a pretty vague framework.  Seems gray to me - and more importantly - to our legal counsel.

Can you refer me to any code section, case law, or perhaps an example of a client of your firm having gone through an audit in such a partnership venture with no difficulty?

As plan advisors, it is the responsibility of all of us in the industry to be very cautious in the language we use when guiding clients.

I cannot tell you how many times I have heard from someone who "read on the internet" or "heard at a guru seminar" that they can do X, Y, or Z - and had to walk them back from potentially destroying their IRA in a self-dealing transaction. They very commonly have either been told flat wrong, or, through their own lack of expertise in these concepts, have entirely mis-interpreted the possibilities.

@Jaime Raskulinecz

Don't know about your experience, but I spoke with quite few investors who were inquiring about partnering with their IRAs. In the vast majority of those cases the reason there wanted to do so is because they were short of funds, so they wanted to pull their IRA funds into the deal "enabling" themselves to do the deal they otherwise were not able to do. I don't consider example above to be a grey area, it is clearly a PROHIBITED TRANSACTION.

What grey area in my opinion is partnering with your IRA when you supposedly CAN do the investment on your own, but decide to do it jointly with your IRA (as you said "to reap tax advantages as well as current income"). As @Brian Eastman elaborated there is nothing in the tax code specifically allowing this scheme. Whenever personal funds pulled together with IRA funds you are opening a "can of worms", the burden would fall on the tax-payer to proof that there are no personal benefits from the use of IRA funds and IRA did not benefit from the use of the personal funds!

When you promote this as a custodian you will benefit by gaining a new client, who will sign a waiver so you have zero liability and they are 100% responsible for all transactions in their IRA. But what is the benefit for the investor to engage in such transaction if they could do the investment with IRA funds alone and avoid the potential risk??

@Dmitriy Fomichenko  and et al ....Thanks for posts.  I am quasi familiar with SDIRA so I thought I may have missed something when I read about the possibility of joint ownership.  Apparently, I have not, but it quite reassuring that there are so many folks that shared their expertise and thoughts.  I fully understand Dmitriy and @Steve C. .

@S Taylor

There are two ways for the IRA participant to invest alongside her IRA in real estate.

Method 1: Tenancy in Common (TIC)

Under this method, tile to the property is taken in both the name of the IRA and in the name of the IRA holder.

Example, 40/60 percent split between the IRA and the IRA participant.

Name of IRA custodian, CFBO Jane Do, IRA, an undivided 40% interest and Jane Do, an undivided 60 interest.

Method 2: LLC

Here the IRA and the IRA participant's funds are both pooled in the same LLC, and the property is purchased in the name of the LLC.

A Few Compliance Notes

Under either method, debt cannot be brought to the table--that is, it has to be an all cash purchase. 

You are still prohibited from using the property for personal use because your IRA directly or indirectly owns an interest in the property.

In the case of the LLC method, neither the IRA nor the participant can inject more funds into the LLC after the initial funding of the LLC.

In sum, you will want work with a competent professional who can help you navigate these rules both at time of setup and going forward because specific rules apply.

@Brian Eastman @Dmitriy Fomichenko We, like most/all custodians don't promote any strategy or recommend any strategy to our clients. If clients wish to do something that we do consider a grey area, or risky, we always tell them to also check with an ERISA specialist who can guide them through the set up and compliance necessary to stay on the right side of the regulations and maintain compliance.

@George Blower thanks for the explanations.